Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-34436
Starwood Property Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland
27-0247747
(State or Other Jurisdiction ofIncorporation or Organization)
(I.R.S. EmployerIdentification No.)
591 West Putnam Avenue
Greenwich, Connecticut
06830
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code:
(203) 422-7700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, $0.01 par value per share
STWD
New York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧
Accelerated filer ◻
Non-accelerated filer ◻
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ⌧
The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of July 31, 2020 was 284,457,492.
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements, including without limitation, statements concerning our operations, economic performance and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are developed by combining currently available information with our beliefs and assumptions and are generally identified by the words “believe,” “expect,” “anticipate” and other similar expressions. Forward-looking statements do not guarantee future performance, which may be materially different from that expressed in, or implied by, any such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their respective dates.
These forward-looking statements are based largely on our current beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or within our control, and which could materially affect actual results, performance or achievements. Factors that may cause actual results to vary from our forward-looking statements include, but are not limited to:
2
In light of these risks and uncertainties, there can be no assurances that the results referred to in the forward-looking statements contained in this Quarterly Report on Form 10-Q will in fact occur. Except to the extent required by applicable law or regulation, we undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, changes to future results over time or otherwise.
3
TABLE OF CONTENTS
Page
Part I
Financial Information
Item 1.
Financial Statements
5
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
6
Condensed Consolidated Statements of Comprehensive Income
7
Condensed Consolidated Statements of Equity
8
Condensed Consolidated Statements of Cash Flows
10
Notes to Condensed Consolidated Financial Statements
12
Note 1 Business and Organization
Note 2 Summary of Significant Accounting Policies
13
Note 3 Acquisitions and Divestitures
19
Note 4 Loans
20
Note 5 Investment Securities
25
Note 6 Properties
28
Note 7 Investment in Unconsolidated Entities
30
Note 8 Goodwill and Intangibles
31
Note 9 Secured Borrowings
33
Note 10 Unsecured Senior Notes
36
Note 11 Loan Securitization/Sale Activities
37
Note 12 Derivatives and Hedging Activity
38
Note 13 Offsetting Assets and Liabilities
40
Note 14 Variable Interest Entities
Note 15 Related-Party Transactions
42
Note 16 Stockholders’ Equity and Non-Controlling Interests
44
Note 17 Earnings per Share
46
Note 18 Accumulated Other Comprehensive Income
47
Note 19 Fair Value
48
Note 20 Income Taxes
55
Note 21 Commitments and Contingencies
57
Note 22 Segment Data
58
Note 23 Subsequent Events
64
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
65
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
105
Item 4.
Controls and Procedures
109
Part II
Other Information
Legal Proceedings
110
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
113
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Item 6.
Exhibits
114
4
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Starwood Property Trust, Inc. and Subsidiaries
(Unaudited, amounts in thousands, except share data)
As of
June 30, 2020
December 31, 2019
Assets:
Cash and cash equivalents
$
347,734
478,388
Restricted cash
176,397
95,643
Loans held-for-investment, net of credit loss allowances of $111,272 and $33,415 ($267,730 and $671,572 held at fair value)
10,420,802
10,586,074
Loans held-for-sale ($626,883 and $764,622 held at fair value)
671,759
884,150
Investment securities, net of credit loss allowances of $6,891 and $0 ($207,602 and $239,600 held at fair value)
752,025
810,238
Properties, net
2,224,323
2,266,440
Intangible assets ($13,955 and $16,917 held at fair value)
76,293
85,700
Investment in unconsolidated entities
104,913
84,329
Goodwill
259,846
Derivative assets
90,905
28,943
Accrued interest receivable
71,748
64,087
Other assets
184,147
211,323
Variable interest entity (“VIE”) assets, at fair value
64,175,387
62,187,175
Total Assets
79,556,279
78,042,336
Liabilities and Equity
Liabilities:
Accounts payable, accrued expenses and other liabilities
211,722
212,006
Related-party payable
20,941
40,925
Dividends payable
138,778
137,427
Derivative liabilities
3,880
8,740
Secured financing agreements, net
8,836,320
8,906,048
Collateralized loan obligations, net
929,307
928,060
Unsecured senior notes, net
1,932,560
1,928,622
VIE liabilities, at fair value
62,617,975
60,743,494
Total Liabilities
74,691,483
72,905,322
Commitments and contingencies (Note 21)
Equity:
Starwood Property Trust, Inc. Stockholders’ Equity:
Preferred stock, $0.01 per share, 100,000,000 shares authorized, no shares issued and outstanding
—
Common stock, $0.01 per share, 500,000,000 shares authorized, 291,573,083 issued and 284,467,522 outstanding as of June 30, 2020 and 287,380,891 issued and 282,200,751 outstanding as of December 31, 2019
2,916
2,874
Additional paid-in capital
5,193,572
5,132,532
Treasury stock (7,105,561 shares and 5,180,140 shares)
(133,024)
(104,194)
Accumulated other comprehensive income
42,866
50,932
Accumulated deficit
(614,093)
(381,719)
Total Starwood Property Trust, Inc. Stockholders’ Equity
4,492,237
4,700,425
Non-controlling interests in consolidated subsidiaries
372,559
436,589
Total Equity
4,864,796
5,137,014
Total Liabilities and Equity
Note: In addition to the VIE assets and liabilities which are separately presented, our condensed consolidated balance sheets as of June 30, 2020 and December 31, 2019 include assets of $1.1 billion and liabilities of $0.9 billion related to a consolidated collateralized loan obligation (“CLO”), which is considered to be a VIE. The CLO’s assets can only be used to settle obligations of the CLO, and the CLO’s liabilities do not have recourse to Starwood Property Trust, Inc. Refer to Note 14 for additional discussion of VIEs.
See notes to condensed consolidated financial statements.
(Unaudited, amounts in thousands, except per share data)
For the Three Months Ended
For the Six Months Ended
June 30,
2020
2019
Revenues:
Interest income from loans
171,103
191,466
388,530
374,882
Interest income from investment securities
14,644
22,545
29,884
40,177
Servicing fees
6,658
9,008
11,451
33,441
Rental income
72,710
87,297
146,856
171,130
Other revenues
491
865
1,445
2,031
Total revenues
265,606
311,181
578,166
621,661
Costs and expenses:
Management fees
23,115
22,523
63,843
45,989
Interest expense
101,493
130,126
221,518
264,798
General and administrative
32,677
37,578
71,379
72,508
Acquisition and investment pursuit costs
1,590
74
2,499
416
Costs of rental operations
29,632
30,655
57,846
60,306
Depreciation and amortization
23,421
28,552
47,401
57,806
Credit loss provision, net
10,202
2,518
58,871
3,281
Other expense
102
1,443
490
1,654
Total costs and expenses
222,232
253,469
523,847
506,758
Other income (loss):
Change in net assets related to consolidated VIEs
51,261
55,158
5,768
102,994
Change in fair value of servicing rights
(2,569)
(916)
(2,962)
(1,683)
Change in fair value of investment securities, net
827
667
3,331
729
Change in fair value of mortgage loans, net
34,450
21,891
18,316
33,157
Earnings (loss) from unconsolidated entities
28,776
8,817
28,873
(34,383)
Gain on sale of investments and other assets, net
6,472
2,515
6,768
7,000
Loss on derivative financial instruments, net
(16,098)
(32)
(6,388)
(2,239)
Foreign currency gain (loss), net
7,173
(7,017)
(27,313)
(1,470)
Loss on extinguishment of debt
(2,207)
(2,816)
(2,377)
(6,114)
Other income (loss), net
204
330
(73)
Total other income
108,289
78,267
24,346
97,918
Income before income taxes
151,663
135,979
78,665
212,821
Income tax benefit (provision)
1,298
(3,533)
8,027
(3,867)
Net income
152,961
132,446
86,692
208,954
Net income attributable to non-controlling interests
(13,305)
(5,430)
(13,805)
(11,555)
Net income attributable to Starwood Property Trust, Inc.
139,656
127,016
72,887
197,399
Earnings per share data attributable to Starwood Property Trust, Inc.:
Basic
0.49
0.45
0.25
0.70
Diluted
(Unaudited, amounts in thousands)
Other comprehensive income (loss) (net change by component):
Available-for-sale securities
6,982
(79)
(8,066)
(466)
Foreign currency translation
1,405
(1,070)
Other comprehensive income (loss)
1,326
(1,536)
Comprehensive income
159,943
133,772
78,626
207,418
Less: Comprehensive income attributable to non-controlling interests
Comprehensive income attributable to Starwood Property Trust, Inc.
146,638
128,342
64,821
195,863
For the Three Months Ended June 30, 2020 and 2019
Total
Starwood
Accumulated
Property
Common stock
Additional
Other
Trust, Inc.
Non-
Par
Paid-in
Treasury Stock
Comprehensive
Stockholders’
Controlling
Shares
Value
Capital
Amount
Deficit
Income
Equity
Interests
Balance, March 31, 2020
289,349,439
2,894
5,159,069
7,105,561
(616,765)
35,884
4,448,058
369,293
4,817,351
Proceeds from DRIP Plan
17,313
216
Equity offering costs
(1)
Share-based compensation
141,009
7,342
7,344
Manager fees paid in stock
2,065,322
26,946
26,966
13,305
Dividends declared, $0.48 per share
(136,984)
Other comprehensive income, net
VIE non-controlling interests
Distributions to non-controlling interests
(10,038)
Balance, June 30, 2020
291,573,083
Balance, March 31, 2019
285,481,485
2,855
5,080,173
5,180,140
(413,553)
55,798
4,621,079
295,888
4,916,967
9,311
212
Redemption of Class A Units for common stock
754,345
16,365
16,373
(16,373)
(3)
206,220
1
7,024
7,025
5,430
(135,321)
(40)
Contributions from non-controlling interests
4,541
(23,902)
Balance, June 30, 2019
286,451,361
2,864
5,103,771
(421,858)
57,124
4,637,707
265,544
4,903,251
Condensed Consolidated Statements of Equity (Continued)
For the Six Months Ended June 30, 2020 and 2019
Balance, December 31, 2019
287,380,891
Cumulative effect of credit loss accounting standard effective January 1, 2020
(32,286)
25,031
369
409,712
8,534
8,538
(8,538)
(15)
Common stock repurchased
1,925,421
(28,830)
1,336,217
14
16,130
16,144
2,421,232
24
36,022
36,046
13,805
Dividends declared, $0.96 per share
(272,975)
Other comprehensive loss, net
(2,189)
9,406
(76,514)
Balance, December 31, 2018
280,839,692
2,808
4,995,156
(348,998)
58,660
4,603,432
296,757
4,900,189
17,136
379
(8)
Conversion of 2019 Convertible Notes
3,611,918
67,526
67,562
732,907
13,381
13,388
Manager incentive fee paid in stock
495,363
10,972
10,977
11,555
(270,259)
(177)
4,636
(30,854)
9
Cash Flows from Operating Activities:
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of deferred financing costs, premiums and discounts on secured borrowings
19,552
17,439
Amortization of discounts and deferred financing costs on unsecured senior notes
3,938
3,849
Accretion of net discount on investment securities
(6,123)
(7,857)
Accretion of net deferred loan fees and discounts
(20,840)
(16,112)
Change in fair value of investment securities
(3,331)
(729)
Change in fair value of consolidated VIEs
62,175
(11,957)
2,962
1,683
Change in fair value of loans
(18,316)
(33,157)
Change in fair value of derivatives
10,531
4,496
Foreign currency loss, net
27,313
1,470
Gain on sale of investments and other assets
(6,768)
(7,000)
Impairment charges on properties and related intangibles
1,392
47,137
57,416
(Earnings) loss from unconsolidated entities
(28,873)
34,383
Distributions of earnings from unconsolidated entities
888
8,056
2,377
6,114
Origination and purchase of loans held-for-sale, net of principal collections
(740,649)
(1,600,100)
Proceeds from sale of loans held-for-sale
1,340,833
928,747
Changes in operating assets and liabilities:
Related-party payable, net
(19,984)
(22,899)
Accrued and capitalized interest receivable, less purchased interest
(80,702)
(54,261)
(16,372)
(18,270)
(3,763)
(12,153)
Net cash provided by (used in) operating activities
769,738
(482,850)
Cash Flows from Investing Activities:
Origination and purchase of loans held-for-investment
(1,666,903)
(2,051,646)
Proceeds from principal collections on loans
999,254
1,342,698
Proceeds from loans sold
435,097
843,344
Purchase and funding of investment securities
(16,120)
Proceeds from sales of investment securities
7,940
3,978
Proceeds from principal collections on investment securities
50,479
73,035
Proceeds from sales of real estate
23,805
1,841
Purchases and additions to properties and other assets
(13,914)
(10,425)
(3,130)
(785)
Proceeds from sale of interest in unconsolidated entities
10,313
Distribution of capital from unconsolidated entities
206
10,041
Payments for purchase or termination of derivatives
(80,911)
(20,212)
Proceeds from termination of derivatives
13,128
8,899
Net cash (used in) provided by investing activities
(240,756)
200,768
Condensed Consolidated Statements of Cash Flows (Continued)
Cash Flows from Financing Activities:
Proceeds from borrowings
3,686,932
3,271,785
Principal repayments on and repurchases of borrowings
(3,716,558)
(2,679,056)
Payment of deferred financing costs
(7,564)
(18,388)
Proceeds from common stock issuances
Payment of equity offering costs
Payment of dividends
(271,624)
(267,301)
Purchase of treasury stock
Issuance of debt of consolidated VIEs
24,376
100,224
Repayment of debt of consolidated VIEs
(236,336)
(91,808)
Distributions of cash from consolidated VIEs
36,989
21,411
Net cash (used in) provided by financing activities
(579,369)
311,020
Net (decrease) increase in cash, cash equivalents and restricted cash
(50,387)
28,938
Cash, cash equivalents and restricted cash, beginning of period
574,031
487,865
Effect of exchange rate changes on cash
487
(605)
Cash, cash equivalents and restricted cash, end of period
524,131
516,198
Supplemental disclosure of cash flow information:
Cash paid for interest
202,648
252,392
Income taxes paid
657
7,270
Supplemental disclosure of non-cash investing and financing activities:
Dividends declared, but not yet paid
137,242
135,615
Consolidation of VIEs (VIE asset/liability additions)
3,077,357
4,104,135
Deconsolidation of VIEs (VIE asset/liability reductions)
303,827
Reclassification of residential loans held-for-investment to held-for-sale
422,691
Loan principal collections temporarily held at master servicer
12,274
Settlement of 2019 Convertible Notes in shares
75,525
Settlement of loans transferred as secured borrowings
74,692
Net assets acquired through foreclosure
27,416
Lease liabilities arising from obtaining right-of-use assets
7,092
11
As of June 30, 2020
(Unaudited)
1. Business and Organization
Starwood Property Trust, Inc. (“STWD” and, together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations in August 2009, upon the completion of our initial public offering. We are focused primarily on originating, acquiring, financing and managing mortgage loans and other real estate investments in both the United States (“U.S.”) and Europe. As market conditions change over time, we may adjust our strategy to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions.
We have four reportable business segments as of June 30, 2020 and we refer to the investments within these segments as our target assets:
Our segments exclude the consolidation of securitization variable interest entities (“VIEs”).
We are organized and conduct our operations to qualify as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, we will generally not be subject to U.S. federal corporate income tax on that portion of our net income that is distributed to stockholders if we distribute at least 90% of our taxable income to our stockholders by prescribed dates and comply with various other requirements.
We are organized as a holding company and conduct our business primarily through our various wholly-owned subsidiaries. We are externally managed and advised by SPT Management, LLC (our “Manager”) pursuant to the terms of a management agreement. Our Manager is controlled by Barry Sternlicht, our Chairman and Chief Executive Officer. Our Manager is an affiliate of Starwood Capital Group, a privately-held private equity firm founded by Mr. Sternlicht.
2. Summary of Significant Accounting Policies
Balance Sheet Presentation of Securitization Variable Interest Entities
We operate investment businesses that acquire unrated, investment grade and non-investment grade rated CMBS and RMBS. These securities represent interests in securitization structures (commonly referred to as special purpose entities, or “SPEs”). These SPEs are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. Under accounting principles generally accepted in the United States of America (“GAAP”), SPEs typically qualify as VIEs. These are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make significant decisions relating to the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity.
Because we often serve as the special servicer or servicing administrator of the trusts in which we invest, or we have the ability to remove and replace the special servicer without cause, consolidation of these structures is required pursuant to GAAP as outlined in detail below. This results in a consolidated balance sheet which presents the gross assets and liabilities of the VIEs. The assets and other instruments held by these VIEs are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the VIEs do not have any recourse to the general credit of any other consolidated entities, nor to us as the consolidator of these VIEs.
The VIE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities are eliminated, as is the interest income related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.
Refer to the segment data in Note 22 for a presentation of our business segments without consolidation of these VIEs.
Basis of Accounting and Principles of Consolidation
The accompanying condensed consolidated financial statements include our accounts and those of our consolidated subsidiaries and VIEs. Intercompany amounts have been eliminated in consolidation. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows have been included.
These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (our “Form 10-K”), as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the operating results for the full year.
Refer to our Form 10-K for a description of our recurring accounting policies. We have included disclosure in this Note 2 regarding principles of consolidation and other accounting policies that (i) are required to be disclosed quarterly, (ii) we view as critical, (iii) became significant since December 31, 2019 due to a corporate action or increase in the significance of the underlying business activity or (iv) changed upon adoption of an Accounting Standards Update (“ASU”) issued by the Financial Accounting Standards Board (“FASB”).
Variable Interest Entities
In addition to the securitization VIEs, we have financed a pool of our loans through a collateralized loan obligation (“CLO”) which is considered a VIE. We also hold interests in certain other entities which are considered VIEs as the limited partners of those entities with equity at risk do not collectively possess (i) the right to remove the general partner or dissolve the partnership without cause or (ii) the right to participate in significant decisions made by the partnership.
We evaluate all of our interests in VIEs for consolidation. When our interests are determined to be variable interests, we assess whether we are deemed to be the primary beneficiary of the VIE. The primary beneficiary of a VIE is required to consolidate the VIE. Accounting Standards Codification (“ASC”) 810, Consolidation, defines the primary beneficiary as the party that has both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant. We consider our variable interests as well as any variable interests of our related parties in making this determination. Where both of these factors are present, we are deemed to be the primary beneficiary and we consolidate the VIE. Where either one of these factors is not present, we are not the primary beneficiary and do not consolidate the VIE.
To assess whether we have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, we consider all facts and circumstances, including our role in establishing the VIE and our ongoing rights and responsibilities. This assessment includes: (i) identifying the activities that most significantly impact the VIE’s economic performance; and (ii) identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE. The right to remove the decision maker in a VIE must be exercisable without cause for the decision maker to not be deemed the party that has the power to direct the activities of a VIE.
To assess whether we have the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, we consider all of our economic interests, including debt and equity investments, servicing fees and other arrangements deemed to be variable interests in the VIE. This assessment requires that we apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by us.
Our purchased investment securities include unrated and non-investment grade rated securities issued by securitization trusts. In certain cases, we may contract to provide special servicing activities for these trusts, or, as holder of the controlling class, we may have the right to name and remove the special servicer for these trusts. In our role as special servicer, we provide services on defaulted loans within the trusts, such as foreclosure or work-out procedures, as permitted by the underlying contractual agreements. In exchange for these services, we receive a fee. These rights give us the ability to direct activities that could significantly impact the trust’s economic performance. However, in those instances where an unrelated third party has the right to unilaterally remove us as special servicer without cause, we do not have the power to direct activities that most significantly impact the trust’s economic performance. We evaluated all of our positions in such investments for consolidation.
For securitization VIEs in which we are determined to be the primary beneficiary, all of the underlying assets, liabilities and equity of the structures are recorded on our books, and the initial investment, along with any associated unrealized holding gains and losses, are eliminated in consolidation. Similarly, the interest income earned from these structures, as well as the fees paid by these trusts to us in our capacity as special servicer, are eliminated in consolidation. Further, an allocable portion of the identified servicing intangible asset associated with the servicing fee streams, and the corresponding allocable amortization or change in fair value of the servicing intangible asset, are also eliminated in consolidation.
We perform ongoing reassessments of: (i) whether any entities previously evaluated under the majority voting interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework, and (ii) whether changes in the facts and circumstances regarding our involvement with a VIE causes our consolidation conclusion regarding the VIE to change.
We elect the fair value option for initial and subsequent recognition of the assets and liabilities of our consolidated securitization VIEs. Interest income and interest expense associated with these VIEs are no longer relevant on a standalone basis because these amounts are already reflected in the fair value changes. We have elected to present these items in a single line on our condensed consolidated statements of operations. The residual difference shown on our condensed consolidated statements of operations in the line item “Change in net assets related to consolidated VIEs” represents our beneficial interest in the VIEs.
We separately present the assets and liabilities of our consolidated securitization VIEs as individual line items on our condensed consolidated balance sheets. The liabilities of our consolidated securitization VIEs consist solely of obligations to the bondholders of the related trusts, and are thus presented as a single line item entitled “VIE liabilities.” The assets of our consolidated securitization VIEs consist principally of loans, but at times, also include foreclosed loans which have been temporarily converted into real estate owned (“REO”). These assets in the aggregate are likewise presented as a single line item entitled “VIE assets.”
Loans comprise the vast majority of our securitization VIE assets and are carried at fair value due to the election of the fair value option. When an asset becomes REO, it is due to non-performance of the loan. Because the loan is already at fair value, the carrying value of an REO asset is also initially at fair value. Furthermore, when we consolidate a trust, any existing REO would be consolidated at fair value. Once an asset becomes REO, its disposition time is relatively short. As a result, the carrying value of an REO generally approximates fair value under GAAP.
In addition to sharing a similar measurement method as the loans in a trust, the securitization VIE assets as a whole can only be used to settle the obligations of the consolidated VIE. The assets of our securitization VIEs are not individually accessible by the bondholders, which creates inherent limitations from a valuation perspective. Also creating limitations from a valuation perspective is our role as special servicer, which provides us very limited visibility, if any, into the performing loans of a trust.
REO assets generally represent a very small percentage of the overall asset pool of a trust. In new issue trusts there are no REO assets. We estimate that REO assets constitute approximately 1% of our consolidated securitization VIE assets, with the remaining 99% representing loans. However, it is important to note that the fair value of our securitization VIE assets is determined by reference to our securitization VIE liabilities as permitted under ASU 2014-13, Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity. In other words, our VIE liabilities are more reliably measurable than the VIE assets, resulting in our current measurement methodology which utilizes this value to determine the fair value of our securitization VIE assets as a whole. As a result, these percentages are not necessarily indicative of the relative fair values of each of these asset categories if the assets were to be valued individually.
Due to our accounting policy election under ASU 2014-13, separately presenting two different asset categories would result in an arbitrary assignment of value to each, with one asset category representing a residual amount, as opposed to its fair value. However, as a pool, the fair value of the assets in total is equal to the fair value of the liabilities.
For these reasons, the assets of our securitization VIEs are presented in the aggregate.
Fair Value Option
The guidance in ASC 825, Financial Instruments, provides a fair value option election that allows entities to make an irrevocable election of fair value as the initial and subsequent measurement attribute for certain eligible financial assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The decision to elect the fair value option is determined on an instrument by instrument basis and must be applied to an entire instrument and is irrevocable once elected. Assets and liabilities measured at fair value pursuant to this guidance are required to be reported separately in our consolidated balance sheets from those instruments using another accounting method.
We have elected the fair value option for certain eligible financial assets and liabilities of our consolidated securitization VIEs, residential loans held-for-investment, loans held-for-sale originated or acquired for future securitization and purchased CMBS issued by VIEs we could consolidate in the future. The fair value elections for VIE and securitization related items were made in order to mitigate accounting mismatches between the carrying value of the instruments and the related assets and liabilities that we consolidate at fair value. The fair value elections for residential mortgage loans held-for-investment were made in order to maintain consistency across all our residential mortgage loans. The fair value elections for mortgage loans held-for-sale were made due to the expected short-term holding period of these instruments.
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Fair Value Measurements
We measure our mortgage-backed securities, derivative assets and liabilities, domestic servicing rights intangible asset and any assets or liabilities where we have elected the fair value option at fair value. When actively quoted observable prices are not available, we either use implied pricing from similar assets and liabilities or valuation models based on net present values of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors.
As discussed above, we measure the assets and liabilities of consolidated securitization VIEs at fair value pursuant to our election of the fair value option. The securitization VIEs in which we invest are “static”; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets and liabilities of the securitization VIEs, we maximize the use of observable inputs over unobservable inputs. Refer to Note 19 for further discussion regarding our fair value measurements.
Loans Held-for-Investment
Loans that are held for investment are carried at cost, net of unamortized acquisition premiums or discounts, loan fees, and origination costs as applicable, unless the loans are credit deteriorated or we have elected to apply the fair value option at purchase.
Loans Held-For-Sale
Our loans that we intend to sell or liquidate in the short-term are classified as held-for-sale and are carried at the lower of amortized cost or fair value, unless we have elected to apply the fair value option at origination or purchase.
Credit Losses
Loans and Debt Securities Measured at Amortized Cost
ASC 326, Financial Instruments – Credit Losses, became effective for the Company on January 1, 2020. ASC 326 mandates the use of a current expected credit loss model (“CECL”) for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” credit model previously required under GAAP. The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to only estimating credit losses upon the occurrence of a discrete loss event under the previous “incurred loss” methodology. The CECL model applies to our loans held-for-investment (“HFI”) and our held-to-maturity (“HTM”) debt securities which are carried at amortized cost, including future funding commitments and accrued interest receivable related to those loans and securities. However, as permitted by ASC 326, we have elected not to measure an allowance for credit losses on accrued interest receivable (which is classified separately on our condensed consolidated balance sheet), but rather write off in a timely manner and/or cease accruing interest that would likely be uncollectible. Our adoption of the CECL model resulted in a $32.3 million increase to our total allowance for credit losses, which was recognized as a cumulative-effect adjustment to accumulated deficit as of January 1, 2020.
As we do not have a history of realized credit losses on our HFI loans and HTM securities, we have subscribed to third party database services to provide us with historical industry losses for both commercial real estate and infrastructure loans. Using these losses as a benchmark, we determine expected credit losses for our loans and securities on a collective basis within our commercial real estate and infrastructure portfolios. See Note 4 for further discussion of our methodologies.
We also evaluate each loan and security measured at amortized cost for credit deterioration at least quarterly. Credit deterioration occurs when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan or security. If a loan or security is considered to be credit deteriorated, we depart from the industry loss rate approach described above and determine the credit loss allowance as any excess of the amortized cost basis of the loan or security over (i) the present value of expected future cash flows discounted at the contractual effective interest rate or (ii) the fair value of the collateral, if repayment is expected solely from the collateral.
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Available-for-Sale Debt Securities
Separate provisions of ASC 326 apply to our available-for-sale (“AFS”) debt securities, which are carried at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income (“AOCI”). We are required to establish an initial credit loss allowance for those securities that are purchased with credit deterioration (“PCD”) by grossing up the amortized cost basis of each security and providing an offsetting credit loss allowance for the difference between expected cash flows and contractual cash flows, both on a present value basis. As of the January 1, 2020 effective date, no such credit loss allowance gross-up was required on our AFS debt securities with PCD due to their individual unrealized gain positions as of that date.
Subsequently, cumulative adverse changes in expected cash flows on our AFS debt securities are recognized currently as an increase to the allowance for credit losses. However, the allowance is limited to the amount by which the AFS debt security’s amortized cost exceeds its fair value. Favorable changes in expected cash flows are first recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Such changes would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero. A change in expected cash flows that is attributable solely to a change in a variable interest reference rate does not result in a credit loss and is accounted for as a prospective yield adjustment.
ASU 2017-04, Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment, became effective for the Company on January 1, 2020. This ASU specifies that goodwill impairment be measured as the excess of the reporting unit’s carrying value (inclusive of goodwill) over its fair value, eliminating the requirement that all assets and liabilities of the reporting unit be remeasured individually in connection with measurement of goodwill impairment.
Revenue Recognition
Interest Income
Interest income on performing loans and financial instruments is accrued based on the outstanding principal amount and contractual terms of the instrument. For loans where we do not elect the fair value option, origination fees and direct loan origination costs are also recognized in interest income over the loan term as a yield adjustment using the effective interest method. When we elect the fair value option, origination fees and direct loan costs are recorded directly in income and are not deferred. Discounts or premiums associated with the purchase of non-performing loans and investment securities are amortized or accreted into interest income as a yield adjustment on the effective interest method, based on expected cash flows through the expected maturity date of the investment. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections.
We cease accruing interest on non-performing loans at the earlier of (i) the loan becoming significantly past due or (ii) management concluding that a full recovery of all interest and principal is doubtful. Interest income on non-accrual loans in which management expects a full recovery of the loan’s outstanding principal balance is only recognized when received in cash. If a full recovery of principal is doubtful, the cost recovery method is applied whereby any cash received is applied to the outstanding principal balance of the loan. A non-accrual loan is returned to accrual status at such time as the loan becomes contractually current and management believes all future principal and interest will be received according to the contractual loan terms.
For loans acquired with deteriorated credit quality, interest income is only recognized to the extent that our estimate of undiscounted expected principal and interest exceeds our investment in the loan. Accretable yield, if any, is recognized as interest income on a level-yield basis over the life of the loan.
Upon the sale of loans or securities which are not accounted for pursuant to the fair value option, the excess (or deficiency) of net proceeds over the net carrying value of such loans or securities is recognized as a realized gain (loss).
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Servicing Fees
We typically seek to be the special servicer on CMBS transactions in which we invest. When we are appointed to serve in this capacity, we earn special servicing fees from the related activities performed, which consist primarily of overseeing the workout of under-performing and non-performing loans underlying the CMBS transactions. These fees are recognized in income in the period in which the services are performed and the revenue recognition criteria have been met.
Rental Income
Rental income is recognized when earned from tenants. For leases that provide rent concessions or fixed escalations over the lease term, rental income is recognized on a straight-line basis over the noncancelable term of the lease. In net lease arrangements, costs reimbursable from tenants are recognized in rental income in the period in which the related expenses are incurred as we are generally the primary obligor with respect to purchasing goods and services for property operations. In instances where the tenant is responsible for property maintenance and repairs and contracts and settles such costs directly with third party service providers, we do not reflect those expenses in our consolidated statement of operations as the tenant is the primary obligor.
Earnings Per Share
We present both basic and diluted earnings per share (“EPS”) amounts in our financial statements. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted EPS reflects the maximum potential dilution that could occur from (i) our share-based compensation, consisting of unvested restricted stock (“RSAs”) and restricted stock units (“RSUs”), (ii) shares contingently issuable to our Manager, (iii) the conversion options associated with our outstanding convertible senior notes (the “Convertible Notes”) (see Notes 10 and 17) and (iv) non-controlling interests that are redeemable with our common stock (see Note 16). Potential dilutive shares are excluded from the calculation if they have an anti-dilutive effect in the period.
Nearly all of the Company’s unvested RSUs and RSAs contain rights to receive non-forfeitable dividends and thus are participating securities. In addition, the non-controlling interests that are redeemable with our common stock are considered participating securities because they earn a preferred return indexed to the dividend rate on our common stock (see Note 16). Due to the existence of these participating securities, the two-class method of computing EPS is required, unless another method is determined to be more dilutive. Under the two-class method, undistributed earnings are reallocated between shares of common stock and participating securities. For the three and six months ended June 30, 2020 and 2019, the two-class method resulted in the most dilutive EPS calculation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. The most significant and subjective estimate that we make is the projection of cash flows we expect to receive on our investments, which has a significant impact on the amount of income that we record and/or disclose. In addition, the fair value of financial assets and liabilities that are estimated using a discounted cash flows method is significantly impacted by the rates at which we estimate market participants would discount the expected cash flows.
In December 2019, a novel strain of coronavirus (“COVID-19”) was reported to have surfaced in Wuhan, China. COVID-19 has since spread to over 200 countries and territories, including every state in the U.S and in cities and regions where our corporate headquarters and/or properties that secure our investments, or properties that we own, are located, and is continuing to spread. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and since then, numerous countries, including the U.S., have declared national emergencies with respect to COVID-19 and have instituted “stay-at-home” guidelines or orders to help prevent its spread. Such actions are creating disruption in global supply chains, increasing rates of unemployment and adversely impacting many industries. The outbreak could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions. We believe the estimates and assumptions underlying
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our consolidated financial statements are reasonable and supportable based on the information available as of June 30, 2020. However, uncertainty over the ultimate impact COVID-19 will have on the global economy generally, and our business in particular, makes any estimates and assumptions as of June 30, 2020 inherently less certain than they would be absent the current and potential impacts of COVID-19. Actual results may ultimately differ from those estimates.
Recent Accounting Developments
On March 12, 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848) – Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. This ASU is effective as of March 12, 2020 through December 31, 2022. The Company has not adopted any of the optional expedients or exceptions through June 30, 2020, but will continue to evaluate the possible adoption of any such expedients or exceptions during the effective period as circumstances evolve.
3. Acquisitions and Divestitures
Investing and Servicing Segment Property Portfolio
During the three and six months ended June 30, 2020, we sold a property within the Investing and Servicing Segment for $24.1 million. In connection with this sale, we recognized a gain of $7.4 million within gain on sale of investments and other assets in our condensed consolidated statements of operations. There were no Investing and Servicing Segment properties sold during the three and six months ended June 30, 2019.
4. Loans
Our loans held-for-investment are accounted for at amortized cost and our loans held-for-sale are accounted for at the lower of cost or fair value, unless we have elected the fair value option for either. The following tables summarize our investments in mortgages and loans as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Weighted
Average Life
Carrying
Face
Average
(“WAL”)
Coupon (1)
(years)(2)
Loans held-for-investment:
Commercial loans:
First mortgages (3)
8,095,262
8,114,492
5.3
%
1.7
Subordinated mortgages (4)
68,891
70,101
8.8
3.3
Mezzanine loans (3)
593,823
593,505
10.3
1.9
30,804
34,452
8.9
2.1
Total commercial loans
8,788,780
8,812,550
Infrastructure first priority loans
1,475,564
1,493,693
4.2
4.5
Residential mortgage loans, fair value option (5)
267,730
260,542
6.2
3.8
Total loans held-for-investment
10,532,074
10,566,785
Loans held-for-sale:
Residential, fair value option (5)
432,786
429,966
3.7
Commercial, fair value option
194,097
191,229
3.9
10.0
Infrastructure, lower of cost or fair value
45,001
46,111
1.6
Total loans held-for-sale
671,884
667,306
Total gross loans
11,203,958
11,234,091
Credit loss allowances:
Commercial loans held-for-investment
(94,947)
Infrastructure loans held-for-investment
(16,325)
Total held-for-investment allowances
(111,272)
Infrastructure loans held-for-sale with a fair value allowance
(125)
Total allowances
(111,397)
Total net loans
11,092,561
7,928,026
7,962,788
5.8
2.0
75,724
77,055
3.4
484,164
484,408
11.0
62,555
66,525
8.2
8,550,469
8,590,776
1,397,448
1,416,164
5.6
4.9
Residential mortgage loans, fair value option
671,572
654,925
6.1
10,619,489
10,661,865
Residential, fair value option
605,384
587,144
159,238
160,635
119,724
121,271
884,346
869,050
11,503,835
11,530,915
(33,415)
(196)
(33,611)
11,470,224
As of June 30, 2020, our variable rate loans held-for-investment were as follows (dollars in thousands):
Weighted-average
Spread Above Index
Commercial loans
8,195,089
Infrastructure loans
Total variable rate loans held-for-investment
9,670,653
4.1
Credit Loss Allowances
As discussed in Note 2, we do not have a history of realized credit losses on our HFI loans and HTM securities, so we have subscribed to third party database services to provide us with industry losses for both commercial real estate and infrastructure loans. Using these losses as a benchmark, we determine expected credit losses for our loans and securities on a collective basis within our commercial real estate and infrastructure portfolios.
For our commercial loans, we utilize a loan loss model that is widely used among banks and commercial mortgage REITs and is marketed by a leading CMBS data analytics provider. It employs logistic regression to forecast expected losses at the loan level based on a commercial real estate loan securitization database that contains activity dating back to 1998. We provide specific loan-level inputs which include loan-to-stabilized-value (LTV) and debt service coverage ratio (DSCR) metrics, as well as principal balances, property type, location, coupon, origination year, term, subordination, expected repayment dates and future fundings. We also select from a group of independent five-year macroeconomic forecasts included in the model that are updated regularly based on current economic trends. We categorize the results by LTV range, which we consider the most significant indicator of credit quality for our commercial loans, as set forth in the credit quality indicator table below. A lower LTV ratio typically indicates a lower credit loss risk.
For our infrastructure loans, we utilize a database of historical infrastructure loan performance that is shared among a consortium of banks and other lenders and compiled by a major bond credit rating agency. The database is representative of industry-wide project finance activity dating back to 1983. We derive historical loss rates from the database filtered by industry, sub-industry, term and construction status for each of our infrastructure loans. Those historical loss rates reflect global economic cycles over a long period of time as well as average recovery rates. However, due to limited information in the first 20 years covered by the database, we have further applied a recessionary multiplier to those historical loss rates as of June 30, 2020 to reflect the current economic deterioration caused by the COVID-19 pandemic which seems to most closely resemble the magnitude of the economic distress of the 2008
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financial crisis. We categorize the results between the power and oil and gas industries, which we consider the most significant indicator of credit quality for our infrastructure loans, as set forth in the credit quality indicator table below.
As discussed in Note 2, we use a discounted cash flow or collateral value approach, rather than the industry loan loss approach described above, to determine credit loss allowances for any credit deteriorated loans.
We regularly evaluate the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral, as well as the financial and operating capability of the borrower. Specifically, the collateral’s operating results and any cash reserves are analyzed and used to assess (i) whether cash flow from operations is sufficient to cover the debt service requirements currently and into the future, (ii) the ability of the borrower to refinance the loan and/or (iii) the collateral’s liquidation value. We also evaluate the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the collateral. In addition, we consider the overall economic environment, real estate or industry sector, and geographic sub-market in which the borrower operates. Such analyses are completed and reviewed by asset management and finance personnel who utilize various data sources, including (i) periodic financial data such as property operating statements, occupancy, tenant profile, rental rates, operating expenses, the borrower’s exit plan, and capitalization and discount rates, (ii) site inspections and (iii) current credit spreads and discussions with market participants.
The significant credit quality indicators for our loans measured at amortized cost, which excludes loans held-for-sale, were as follows as of June 30, 2020 (dollars in thousands):
Term Loans
Revolving Loans
Credit
Amortized Cost Basis by Origination Year
Amortized Cost
Amortized
Loss
2018
2017
2016
Prior
Cost Basis
Allowance
Credit quality indicator:
LTV < 60%
499,114
1,004,947
915,109
973,889
152,365
252,631
3,798,055
13,295
LTV 60% - 70%
265,570
1,128,883
1,745,905
449,146
53,418
169,219
3,812,141
41,221
LTV > 70%
31,649
822,181
93,094
60,814
1,007,738
10,578
Credit deteriorated
34,454
7,755
105,589
147,798
29,853
Defeased and other
23,048
Total commercial
796,333
2,956,011
2,788,562
1,430,790
205,783
611,301
94,947
Infrastructure loans:
Power
248,691
304,589
123,558
189,365
302,918
24,736
1,193,857
9,139
Oil and gas
196,775
84,932
281,707
7,186
Total infrastructure
445,466
389,521
16,325
Residential loans held-for-investment, fair value option
Loans held-for-sale
125
111,397
As of June 30, 2020, certain first mortgage, mezzanine and unsecured promissory loans with an amortized cost basis of $101.4 million related to a residential conversion project and two subordinated mortgages on department stores with an amortized cost basis of $12.0 million were credit deteriorated and 90 days or greater past due, as were $14.0 million of residential loans. In accordance with our interest income recognition policy, these loans, along with a $34.5 million credit deteriorated loan that is not 90 days or greater past due (also related to the residential conversion project), were placed on non-accrual status. We apply the cost recovery method of interest income recognition for all these credit deteriorated loans. Any loans which are modified to provide for the deferral of interest are not considered past due and are accounted for in accordance with our revenue recognition policy on interest income.
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The following tables present the activity in our credit loss allowance for funded loans and unfunded commitments (amounts in thousands):
Funded Commitments Credit Loss Allowance
Loans
Held-for-Sale
Six Months Ended June 30, 2020
Commercial
Infrastructure
Funded Loans
Credit loss allowance at December 31, 2019
33,415
196
33,611
Cumulative effect of ASC 326 effective January 1, 2020
10,112
10,328
20,440
51,420
5,997
57,417
Charge-offs
(71)
Recoveries
Credit loss allowance at June 30, 2020
Unfunded Commitments Credit Loss Allowance (1)
HTM Preferred
Interests (2)
8,348
2,205
10,553
Credit loss (reversal) provision, net
(3,303)
1,371
625
(1,307)
5,045
3,576
9,246
Memo: Unfunded commitments as of June 30, 2020 (3)
1,870,914
132,905
6,419
2,010,238
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Loan Portfolio Activity
The activity in our loan portfolio was as follows (amounts in thousands):
Held-for-Investment Loans
Residential
Held-for-Sale Loans
Total Loans
Balance at December 31, 2019
8,517,054
(10,112)
(10,328)
(20,440)
Acquisitions/originations/additional funding
1,452,753
113,430
100,720
786,860
2,453,763
Capitalized interest (1)
70,346
Basis of loans sold (2)
(397,038)
(604)
(1,378,952)
(1,776,594)
Loan maturities/principal repayments
(831,319)
(68,585)
(64,806)
(43,593)
(1,008,303)
Discount accretion/premium amortization
19,706
1,025
20,840
Changes in fair value
(16,461)
34,777
Unrealized foreign currency translation loss
(76,137)
(2,037)
(78,174)
(51,420)
(5,997)
(57,417)
Transfer to/from other asset classifications
32,246
(422,691)
390,445
Balance at June 30, 2020
8,693,833
1,459,239
Transferred
As Secured
Six Months Ended June 30, 2019
Borrowings
Balance at December 31, 2018
7,075,577
1,456,779
1,187,552
74,346
9,794,254
1,707,180
334,303
1,663,244
3,704,727
52,405
(495,456)
(1,271,931)
(1,767,387)
(959,160)
(333,607)
(80,134)
(74,692)
(1,447,593)
15,448
318
346
16,112
Unrealized foreign currency translation (loss) gain
(5,396)
1,493
(3,903)
(2,085)
(1,196)
(3,281)
Loan foreclosures
(27,303)
46,495
(101,282)
54,714
Balance at June 30, 2019
7,407,705
1,356,511
1,586,899
10,351,115
(1) Represents accrued interest income on loans whose terms do not require current payment of interest.
(2) See Note 11 for additional disclosure on these transactions.
5. Investment Securities
Investment securities were comprised of the following as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Carrying Value as of
RMBS, available-for-sale
174,281
189,576
RMBS, fair value option (1)
328,270
147,034
CMBS, fair value option (1), (2)
1,198,784
1,295,363
HTM debt securities, amortized cost net of credit loss allowance of $6,891 and $0
544,423
570,638
Equity security, fair value
9,791
12,664
Subtotal—Investment securities
2,255,549
2,215,275
VIE eliminations (1)
(1,503,524)
(1,405,037)
Total investment securities
Purchases, sales and principal collections for all investment securities were as follows (amounts in thousands):
RMBS,
RMBS, fair
CMBS, fair
HTM
Securitization
available-for-sale
value option
Securities
Security
VIEs (1)
Three Months Ended June 30, 2020
Purchases/fundings
185,433
10,391
(185,433)
Sales
Principal collections
6,014
11,532
927
30,713
(12,266)
36,920
Three Months Ended June 30, 2019
Purchases
38,951
(38,951)
41,501
25,795
(66,546)
750
6,417
3,058
12,072
53,462
(9,728)
65,281
214,725
7,661
16,120
(222,386)
32,316
(24,376)
12,563
20,104
17,450
37,351
(36,989)
26,272
52,213
(78,485)
62,701
(100,224)
12,777
5,092
21,909
54,668
(21,411)
RMBS, Available-for-Sale
The Company classified all of its RMBS not eliminated in consolidation as available-for-sale as of June 30, 2020 and December 31, 2019. These RMBS are reported at fair value in the balance sheet with changes in fair value recorded in accumulated other comprehensive income (“AOCI”).
The tables below summarize various attributes of our investments in available-for-sale RMBS as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Unrealized Gains or (Losses)
Recognized in AOCI
Gross
Net
Unrealized
Fair Value
Cost
Basis
Gains
Losses
Adjustment
RMBS
131,351
43,179
(249)
42,930
138,580
N/A
51,310
(314)
50,996
Weighted Average Coupon (1)
Weighted Average Rating
WAL (Years) (2)
B+
3.1
BB-
As of June 30, 2020, approximately $147.7 million, or 84.8%, of RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.26%. As of December 31, 2019, approximately $160.9 million, or 84.9%, of RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.24%. We purchased all of the RMBS at a discount, a portion of which is accreted into income over the expected remaining life of the security. The majority of the income from this strategy is earned from the accretion of this accretable discount.
We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $0.3 million and $0.4 million for the three months ended June 30, 2020 and 2019, respectively, and $0.7 million and $0.8 million for the six months ended June 30, 2020 and 2019, respectively, recorded as management fees in the accompanying condensed consolidated statements of operations.
The following table presents the gross unrealized losses and estimated fair value of any available-for-sale securities that were in an unrealized loss position as of June 30, 2020 and December 31, 2019, and for which an allowance for credit losses has not been recorded (amounts in thousands):
Estimated Fair Value
Unrealized Losses
Securities with a
loss less than
loss greater than
12 months
675
1,173
(19)
(230)
As of December 31, 2019
1,380
As of June 30, 2020 and December 31, 2019, there were three securities and one security, respectively, with unrealized losses reflected in the table above. After evaluating the securities and recording adjustments for credit losses, we concluded that the remaining unrealized losses reflected above were noncredit-related and would be recovered from the securities’ estimated future cash flows. We considered a number of factors in reaching this conclusion, including that we did not intend to sell the securities, it was not considered more likely than not that we would be forced to sell the securities prior to recovering our amortized cost, and there were no material credit events that would have caused us to otherwise conclude that we would not recover our cost. Credit losses are calculated by comparing (i) the estimated future cash flows of each security discounted at the yield determined as of the initial acquisition date or, if since revised, as of
26
the last date previously revised, to (ii) our net amortized cost basis. Significant judgment is used in projecting cash flows for our non-agency RMBS. As a result, actual income and/or credit losses could be materially different from what is currently projected and/or reported.
CMBS and RMBS, Fair Value Option
As discussed in the “Fair Value Option” section of Note 2 herein, we elect the fair value option for certain CMBS and RMBS in an effort to eliminate accounting mismatches resulting from the current or potential consolidation of securitization VIEs. As of June 30, 2020, the fair value and unpaid principal balance of CMBS where we have elected the fair value option, excluding the notional value of interest-only securities and before consolidation of securitization VIEs, were $1.2 billion and $2.7 billion, respectively. As of June 30, 2020, the fair value and unpaid principal balance of RMBS where we have elected the fair value option, excluding the notional value of interest-only securities and before consolidation of securitization VIEs, were $328.3 million and $266.8 million, respectively. The $1.5 billion total fair value balance of CMBS and RMBS represents our economic interests in these assets. However, as a result of our consolidation of securitization VIEs, the vast majority of this fair value (all except $23.5 million at June 30, 2020) is eliminated against VIE liabilities before arriving at our GAAP balance for fair value option investment securities.
As of June 30, 2020, $104.2 million of our CMBS were variable rate and none of our RMBS were variable rate.
HTM Debt Securities, Amortized Cost
The table below summarizes our investments in HTM debt securities as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Credit Loss
Net Carrying
Gross Unrealized
Holding Gains
Holding Losses
CMBS
349,023
(24,236)
324,787
Preferred interests
158,971
(3,883)
155,088
(7,587)
147,501
Infrastructure bonds
43,320
(3,008)
40,312
174
(281)
40,205
551,314
(6,891)
(32,104)
512,493
383,473
946
(3,001)
381,418
142,012
1,148
(353)
142,807
45,153
(651)
44,502
2,094
(4,005)
568,727
The following table presents the activity in our credit loss allowance for HTM debt securities (amounts in thousands):
Total HTM
Preferred
Bonds
Cumulative effect of ASC 326 effective January 1, 2020:
Beginning accumulated deficit charge
1,114
179
1,293
Gross-up of PCD bond amortized cost basis
2,837
2,769
2,761
3,883
3,008
6,891
27
The table below summarizes the maturities of our HTM debt securities by type as of June 30, 2020 (amounts in thousands):
Less than one year
35,254
2,656
37,910
One to three years
313,769
140,515
454,284
Three to five years
14,573
Thereafter
37,656
Equity Security, Fair Value Option
During 2012, we acquired 9,140,000 ordinary shares from a related-party in Starwood European Real Estate Finance Limited (“SEREF”), a debt fund that is externally managed by an affiliate of our Manager and is listed on the London Stock Exchange. The fair value of the investment remeasured in USD was $9.8 million and $12.7 million as of June 30, 2020 and December 31, 2019, respectively. As of June 30, 2020, our shares represent an approximate 2% interest in SEREF.
6. Properties
Our properties are held within the following portfolios:
Woodstar I Portfolio
The Woodstar I Portfolio is comprised of 32 affordable housing communities with 8,948 units concentrated primarily in the Tampa, Orlando and West Palm Beach metropolitan areas. During the year ended December 31, 2015, we acquired 18 of the 32 affordable housing communities of the Woodstar I Portfolio with the final 14 communities acquired during the year ended December 31, 2016. The Woodstar I Portfolio includes total gross properties and lease intangibles of $632.8 million and debt of $571.9 million as of June 30, 2020.
Woodstar II Portfolio
The Woodstar II Portfolio is comprised of 27 affordable housing communities with 6,109 units concentrated primarily in Central and South Florida. We acquired eight of the 27 affordable housing communities in December 2017, with the final 19 communities acquired during the year ended December 31, 2018. The Woodstar II Portfolio includes total gross properties and lease intangibles of $607.0 million and debt of $437.0 million as of June 30, 2020.
Medical Office Portfolio
The Medical Office Portfolio is comprised of 34 medical office buildings acquired during the year ended December 31, 2016. These properties, which collectively comprise 1.9 million square feet, are geographically dispersed throughout the U.S. and primarily affiliated with major hospitals or located on or adjacent to major hospital campuses. The Medical Office Portfolio includes total gross properties and lease intangibles of $760.0 million and debt of $591.4 million as of June 30, 2020.
Master Lease Portfolio
The Master Lease Portfolio is comprised of 16 retail properties geographically dispersed throughout the U.S., with more than 50% of the portfolio, by carrying value, located in Florida, Texas and Minnesota. These properties, which we acquired in September 2017, collectively comprise 1.9 million square feet and were leased back to the seller under corporate guaranteed master net lease agreements with initial terms of 24.6 years and periodic rent escalations. The Master Lease Portfolio includes total gross properties of $343.8 million and debt of $192.5 million as of June 30, 2020.
The Investing and Servicing Segment Property Portfolio (“REIS Equity Portfolio”) is comprised of 15 commercial real estate properties and one equity interest in an unconsolidated commercial real estate property which were acquired from CMBS trusts during the previous five years. The REIS Equity Portfolio includes total gross properties and lease intangibles of $264.8 million and debt of $186.2 million as of June 30, 2020.
The table below summarizes our properties held as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Depreciable Life
Property Segment
Land and land improvements
0 – 15 years
484,678
484,397
Buildings and building improvements
5 – 45 years
1,689,142
1,687,756
Furniture & fixtures
3 – 7 years
55,767
52,567
Investing and Servicing Segment
50,817
54,052
3 – 40 years
173,960
182,048
2 – 5 years
2,363
2,139
Commercial and Residential Lending Segment (1)
0 – 10 years
11,415
11,386
10 – 23 years
17,287
16,285
Properties, cost
2,485,429
2,490,630
Less: accumulated depreciation
(261,106)
(224,190)
During the three and six months ended June 30, 2020, we sold an operating property within the REIS Equity Portfolio for $24.1 million. In connection with this sale, we recognized a gain of $7.4 million within gain on sale of investments and other assets in our condensed consolidated statements of operations. No operating properties were sold during the three and six months ended June 30, 2019.
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7. Investment in Unconsolidated Entities
The table below summarizes our investments in unconsolidated entities as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Participation /
Carrying value as of
Ownership % (1)
Equity method:
Retail Fund
33%
Equity interest in a natural gas power plant
10%
24,744
25,862
Investor entity which owns equity in an online real estate company
50%
10,746
9,473
Equity interests in commercial real estate
1,824
1,907
Equity interest in and advances to a residential mortgage originator (2)
11,989
12,002
Various
25% - 50%
8,182
8,339
57,485
57,583
Other:
Equity interest in a servicing and advisory business (3)
2%
17,584
Investment funds which own equity in a loan servicer and other real estate assets
4% - 6%
9,225
0% - 2%
20,619
17,521
47,428
26,746
We own a 33% equity interest in a fund that owns four regional shopping malls (the “Retail Fund”). The fund is an investment company which measures its assets at fair value on a recurring basis. We report our interest in the Retail Fund on a three-month lag basis at its liquidation value. As of December 31, 2019, we impaired the remainder of our investment based on our estimate of unrealized decreases in the fair value of the underlying real estate properties. Such decreases were recognized by the Retail Fund during the period included in the six months ended June 30, 2020.
As of June 30, 2020, the carrying value of our equity investment in a residential mortgage originator exceeded the underlying equity in net assets of such investee by $1.6 million. This difference is the result of the Company recording its investment in the investee at its acquisition date fair value, which included certain non-amortizing intangible assets not recognized by the investee. Should the Company determine these intangible assets held by the investee are impaired, the Company will recognize such impairment loss through earnings from unconsolidated entities in our consolidated statement of operations, otherwise, such difference between the carrying value of our equity investment in the residential mortgage originator and the underlying equity in the net assets of the residential mortgage originator will continue to exist.
Other than our equity interest in the residential mortgage originator, there were no differences between the carrying value of our equity method investments and the underlying equity in the net assets of the investees as of June 30, 2020.
During the three and six months ended June 30, 2020, we did not become aware of (i) any observable price changes in our other investments accounted for under the fair value practicability exception, except as described above with respect to the servicing and advisory business, or (ii) any indicators of impairment.
8. Goodwill and Intangibles
Infrastructure Lending Segment
The Infrastructure Lending Segment’s goodwill of $119.4 million at both June 30, 2020 and December 31, 2019 represents the excess of consideration transferred over the fair value of net assets acquired on September 19, 2018 and October 15, 2018. The goodwill recognized is attributable to value embedded in the acquired Infrastructure Lending Segment’s lending platform.
LNR Property LLC (“LNR”)
The Investing and Servicing Segment’s goodwill of $140.4 million at both June 30, 2020 and December 31, 2019 represents the excess of consideration transferred over the fair value of net assets of LNR acquired on April 19, 2013. The goodwill recognized is attributable to value embedded in LNR’s existing platform, which includes a network of commercial real estate asset managers, work-out specialists, underwriters and administrative support professionals as well as proprietary historical performance data on commercial real estate assets.
Intangible Assets
Servicing Rights Intangibles
In connection with the LNR acquisition, we identified domestic servicing rights that existed at the purchase date, based upon the expected future cash flows of the associated servicing contracts. As of June 30, 2020 and December 31, 2019, the balance of the domestic servicing intangible was net of $34.9 million and $26.2 million, respectively, which was eliminated in consolidation pursuant to ASC 810 against VIE assets in connection with our consolidation of securitization VIEs. Before VIE consolidation, as of June 30, 2020 and December 31, 2019, the domestic servicing intangible had a balance of $48.8 million and $43.2 million, respectively, which represents our economic interest in this asset.
Lease Intangibles
In connection with our acquisitions of commercial real estate, we recognized in-place lease intangible assets and favorable lease intangible assets associated with certain non-cancelable operating leases of the acquired properties.
The following table summarizes our intangible assets, which are comprised of servicing rights intangibles and lease intangibles, as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Gross Carrying
Amortization
Domestic servicing rights, at fair value
13,955
16,917
In-place lease intangible assets
133,244
(87,917)
45,327
135,293
(84,383)
50,910
Favorable lease intangible assets
24,188
(7,177)
17,011
24,218
(6,345)
17,873
Total net intangible assets
171,387
(95,094)
176,428
(90,728)
The following table summarizes the activity within intangible assets for the six months ended June 30, 2020 (amounts in thousands):
Domestic
In-place Lease
Favorable Lease
Servicing
Intangible
Rights
Assets
Balance as of January 1, 2020
(5,413)
(862)
(6,275)
(170)
Changes in fair value due to changes in inputs and assumptions
Balance as of June 30, 2020
The following table sets forth the estimated aggregate amortization of our in-place lease intangible assets and favorable lease intangible assets for the next five years and thereafter (amounts in thousands):
2020 (remainder of)
5,407
2021
9,653
2022
7,871
2023
6,115
2024
4,722
28,570
62,338
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9. Secured Borrowings
Secured Financing Agreements
The following table is a summary of our secured financing agreements in place as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Outstanding Balance at
Current
Extended
Weighted Average
Pledged Asset
Maximum
December 31,
Maturity
Maturity (a)
Pricing
Carrying Value
Facility Size
Repurchase Agreements:
Commercial Loans
Aug 2020 to Jan 2024
(b)
May 2023 to Mar 2029
(c)
6,293,458
9,181,700
(d)
4,024,642
3,640,620
Residential Loans
Jun 2022
LIBOR + 2.58%
10,172
400,000
7,669
11,835
Infrastructure Loans
Feb 2021
LIBOR + 2.00%
194,283
500,000
160,483
188,198
Conduit Loans
Feb 2021 to Jun 2023
Feb 2022 to Jun 2024
LIBOR + 1.86%
182,001
350,000
134,874
86,575
CMBS/RMBS
Sep 2020 to Dec 2029
(e)
Dec 2020 to Jun 2030
(f)
1,097,024
783,641
563,031
(g)
682,229
Total Repurchase Agreements
7,776,938
11,215,341
4,890,699
4,609,457
Other Secured Financing:
Borrowing Base Facility
Apr 2022
Apr 2024
LIBOR + 2.25%
33,445
650,000
(h)
29,333
198,955
Commercial Financing Facility
Mar 2022
Mar 2029
GBP LIBOR + 1.75%
91,214
73,650
Infrastructure Acquisition Facility
Sep 2021
Sep 2022
(i)
723,690
737,137
583,005
603,642
Infrastructure Financing Facilities
Jul 2022 to Oct 2022
Oct 2024 to Jul 2027
LIBOR + 2.11%
567,315
1,250,000
462,568
428,206
Property Mortgages - Fixed rate
Nov 2024 to Aug 2052
(j)
3.81%
1,302,670
1,078,072
1,077,979
1,196,492
Property Mortgages - Variable rate
Nov 2021 to Jul 2030
LIBOR + 2.53%
951,634
945,400
926,262
696,503
Term Loan and Revolver
(k)
517,000
397,000
399,000
FHLB
1.99%
690,341
2,000,000
481,500
867,870
Total Other Secured Financing
4,360,309
7,251,259
4,031,297
4,390,668
12,137,247
18,466,600
8,921,996
9,000,125
Unamortized net discount
(10,189)
(8,347)
Unamortized deferred financing costs
(75,487)
(85,730)
In the normal course of business, the Company is in discussions with its lenders to extend or amend any financing facilities which contain near term expirations.
In January 2020, we entered into a CMBS/RMBS repurchase facility to finance certain CMBS investments within a consolidated joint venture in which we hold a 51% ownership interest. The facility carries a rolling 12-month term which may reset quarterly with the lender’s consent and an annual interest rate of three-month LIBOR + 1.35% to 1.85%. The facility’s maximum facility size is at the discretion of the lender.
In February 2020, we amended a Commercial Loans repurchase facility to increase available borrowings by $200.0 million to $1.8 billion.
In February 2020, we exercised an extension option on a Conduit Loans repurchase facility to extend the current maturity by one year with a one-year extension option.
In February 2020, we exercised an extension option on the Infrastructure Loans repurchase facility to extend the current maturity by one year.
In March 2020, we amended an Infrastructure Financing Facility to increase available borrowings by $250.0 million to $750.0 million.
In March 2020, we entered into a Commercial Financing Facility to finance non-U.S. commercial loans held-for-investment. The facility carries a two-year initial term with three one-year extension options and includes an option to extend the maturity for each underlying asset for up to four additional years. The facility has an annual interest rate of GBP LIBOR + 1.75%. This facility shares up to $500.0 million of $2.0 billion of maximum borrowings with a Commercial Loans repurchase facility.
In June 2020, we amended a Residential Loans repurchase facility with a maximum facility size of $400.0 million to extend the current maturity from February 2021 to June 2022.
In June 2020, we amended a Commercial Loans repurchase facility and a Conduit Loans repurchase facility with an aggregate maximum facility size of $950.0 million to extend the current maturity from June 2022 to June 2023.
During the three months ended June 30, 2020, we entered into mortgage loans with total borrowings of $217.1 million to refinance our Woodstar I Portfolio. The loans carry ten-year terms and weighted average annual interest rates of LIBOR + 2.71%. A portion of the net proceeds from the mortgage loans was used to repay $117.0 million of outstanding government sponsored mortgage loans. We recognized a loss on extinguishment of debt of $2.2 million in our condensed consolidated statements of operations in connection with the repayment of the government sponsored mortgage loans.
Our secured financing agreements contain certain financial tests and covenants. As of June 30, 2020, we were in compliance with all such covenants.
We seek to mitigate risks associated with our repurchase agreements by managing risk related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value. The margin call provisions under the majority of our repurchase facilities, consisting of 76% of these agreements, do not permit valuation adjustments based on capital markets activity. Instead, margin calls on these facilities are limited to collateral-specific credit marks. To monitor credit risk associated with the performance and value of our loans and investments, our asset management team regularly reviews our investment portfolios and is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary. For the 24% of repurchase agreements containing margin call provisions for general capital markets activity, approximately 16% of these pertain to our loans held-for-sale, for which we manage credit risk through the purchase of credit index instruments. We further seek to manage risks associated with our repurchase agreements by matching the maturities and interest rate characteristics of our loans with the related repurchase agreement.
34
For the three and six months ended June 30, 2020, approximately $9.0 million and $17.8 million, respectively, of amortization of deferred financing costs from secured financing agreements was included in interest expense on our condensed consolidated statements of operations. For the three and six months ended June 30, 2019, approximately $8.1 million and $16.8 million, respectively, of amortization of deferred financing costs from secured financing agreements was included in interest expense on our condensed consolidated statements of operations.
Collateralized Loan Obligations
In August 2019, we refinanced a pool of our commercial loans held-for-investment through a CLO, STWD 2019-FL1. On the closing date, the CLO issued $1.1 billion principal amount of notes, of which $936.4 million was purchased by third party investors. We retained $86.6 million of notes, along with preferred shares with a liquidation preference of $77.0 million. The CLO contains a reinvestment feature that, subject to certain eligibility criteria, allows us to contribute new loans or participation interests in loans to the CLO in exchange for cash. During the six months ended June 30, 2020, we utilized the reinvestment feature, contributing $85.3 million of additional interests into the CLO.
The following table is a summary of our CLO as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Count
Average Spread
Collateral assets
1,099,442
1,099,405
LIBOR + 3.66%
(a)
Jan 2024
Financing
936,375
LIBOR + 1.64%
July 2038
1,073,504
LIBOR + 3.34%
Nov 2023
LIBOR + 1.65%
We incurred $9.2 million of issuance costs in connection with the CLO, which are amortized on an effective yield basis over the estimated life of the CLO. For the three and six months ended June 30, 2020, approximately $0.6 million and $1.2 million, respectively, of amortization of deferred financing costs was included in interest expense on our condensed consolidated statements of operations. As of June 30, 2020 and December 31, 2019, our unamortized issuance costs were $7.1 million and $8.3 million, respectively.
The CLO is considered a VIE, for which we are deemed the primary beneficiary. We therefore consolidate the CLO. Refer to Note 14 for further discussion.
35
Maturities
Our credit facilities generally require principal to be paid down prior to the facilities’ respective maturities if and when we receive principal payments on, or sell, the investment collateral that we have pledged. The following table sets forth our principal repayments schedule for secured financings based on the earlier of (i) the extended contractual maturity of each credit facility or (ii) the extended contractual maturity of each of the investments that have been pledged as collateral under the respective credit facility (amounts in thousands):
Repurchase
Other Secured
Agreements
CLO
220,863
186,076
406,939
566,939
791,713
1,358,652
1,269,283
548,974
1,818,257
1,026,265
710,656
1,736,921
1,312,435
238,357
1,550,792
494,914
1,555,521
2,986,810
9,858,371
10. Unsecured Senior Notes
The following table is a summary of our unsecured senior notes outstanding as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Remaining
Coupon
Effective
Period of
Carrying Value at
Rate
Rate (1)
Date
2021 Senior Notes (February)
3.63
3.89
2/1/2021
0.6
years
2021 Senior Notes (December)
5.00
5.32
12/15/2021
1.5
700,000
2023 Convertible Notes
4.38
4.86
4/1/2023
2.8
250,000
2025 Senior Notes
4.75
5.04
3/15/2025
4.7
Total principal amount
1,950,000
Unamortized discount—Convertible Notes
(3,091)
(3,610)
Unamortized discount—Senior Notes
(9,922)
(12,144)
(4,427)
(5,624)
Carrying amount of debt components
Carrying amount of conversion option equity components recorded in additional paid-in capital for outstanding convertible notes
3,755
Convertible Senior Notes
We recognized interest expense of $3.1 million and $6.1 million during the three and six months ended June 30, 2020, respectively, from our unsecured Convertible Notes. We recognized interest expense of $3.0 million and $6.2 million during the three and six months ended June 30, 2019, respectively, from our unsecured Convertible Notes.
The following table details the conversion attributes of our Convertible Notes outstanding as of June 30, 2020:
Conversion
Price (2)
38.5959
25.91
The if-converted value of the 2023 Convertible Notes was less than their principal amount by $105.7 million at June 30, 2020 as the closing market price of the Company’s common stock of $14.96 was less than the implicit conversion price of $25.91 per share. The if-converted value of the principal amount of the 2023 Convertible Notes was $144.3 million as of June 30, 2020.
11. Loan Securitization/Sale Activities
As described below, we regularly sell loans and notes under various strategies. We evaluate such sales as to whether they meet the criteria for treatment as a sale—legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint and transfer of control.
Loan Securitizations
Within the Investing and Servicing Segment, we originate commercial mortgage loans with the intent to sell these mortgage loans to VIEs for the purposes of securitization. These VIEs then issue CMBS that are collateralized in part by these assets, as well as other assets transferred to the VIE by third parties. Within the Commercial and Residential Lending Segment, we acquire residential mortgage loans with the intent to sell these mortgage loans to VIEs for the purpose of securitization. These VIEs then issue RMBS that are collateralized by these assets. In certain instances, we retain an interest in the CMBS or RMBS VIE and/or serve as special servicer or servicing administrator for the VIE. In these circumstances, we generally consolidate the VIE into which the loans were sold. The following summarizes the face amount and proceeds of commercial and residential loans securitized for the three and six months ended June 30, 2020 and 2019 (amounts in thousands):
Face Amount
Proceeds
For the Three Months Ended June 30,
583,501
589,693
345,221
365,377
For the Six Months Ended June 30,
335,835
352,393
964,780
988,440
524,632
552,218
340,211
352,012
The securitization of these commercial and residential loans does not result in a discrete gain or loss since they are carried under the fair value option.
Our securitizations have each been structured as bankruptcy-remote entities whose assets are not intended to be available to the creditors of any other party.
Commercial and Residential Loan Sales
Within the Commercial and Residential Lending Segment, we originate or acquire commercial mortgage loans, subsequently selling all or a portion thereof. Typically, our motivation for entering into these transactions is to effectively create leverage on the subordinated position that we will retain and hold for investment. We also may sell certain of our previously-acquired residential loans to third parties outside a securitization. The following table summarizes our loans sold by the Commercial and Residential Lending Segment, net of expenses (amounts in thousands):
Loan Transfers Accounted for as Sales
Face Amount (1)
Proceeds (1)
399,132
396,078
102,681
102,141
1,635
1,653
550
604
501,422
498,451
23,842
24,517
During both the three and six months ended June 30, 2020, losses recognized by the Commercial and Residential Lending Segment on sales of commercial loans were $1.0 million. During the three and six months ended June 30, 2019, gains recognized by the Commercial and Residential Lending Segment on sales of commercial loans were $0.2 million and $3.0 million, respectively. The sale of residential loans does not result in a discrete gain or loss since they are carried under the fair value option.
Infrastructure Loan Sales
During the six months ended June 30, 2020, the Infrastructure Lending Segment sold loans held-for-sale with an aggregate face amount of $38.7 million for proceeds of $38.4 million, recognizing gains of $0.3 million. There were no sales of loans by the Infrastructure Lending Segment during the three months ended June 30, 2020. During the three and six months ended June 30, 2019, the Infrastructure Lending Segment sold loans held-for-sale with an aggregate face amount of $176.5 million and $356.8 million, respectively, for proceeds of $173.6 million and $346.3 million, respectively, recognizing gains of $2.3 million and $3.1 million, respectively. In connection with these sales, we sold an interest rate swap guarantee for cash payment of $3.1 million and recognized a decrease in fair value of $2.7 million within loss on derivative financial instruments, net in our condensed consolidated statements of operations during the three and six months ended June 30, 2019. Refer to Note 12 for further discussion of our interest rate swap guarantees.
12. Derivatives and Hedging Activity
Risk Management Objective of Using Derivatives
We are exposed to certain risks arising from both our business operations and economic conditions. Refer to Note 13 to the consolidated financial statements included in our Form 10-K for further discussion of our risk management objectives and policies.
Designated Hedges
The Company does not generally elect to apply the hedge accounting designation to its hedging instruments. As of June 30, 2020 and December 31, 2019, the Company did not have any designated hedges.
Non-designated Hedges and Derivatives
We have entered into the following types of non-designated hedges and derivatives:
The following table summarizes our non-designated derivatives as of June 30, 2020 (notional amounts in thousands):
Type of Derivative
Number of Contracts
Aggregate Notional Amount
Notional Currency
Fx contracts – Buy Euros ("EUR")
1,915
EUR
November 2022
Fx contracts – Sell EUR
277
228,011
August 2020 – November 2025
Fx contracts – Sell Pounds Sterling ("GBP")
97
315,411
GBP
July 2020 – December 2023
Fx contracts – Sell Australian dollar ("AUD")
85,592
AUD
August 2021 – November 2021
Interest rate swaps – Paying fixed rates
45
1,950,878
USD
August 2022 – March 2030
Interest rate swaps – Receiving fixed rates
970,000
January 2021- March 2025
Interest rate caps
959,706
September 2020 – April 2025
Credit index instruments
69,000
September 2058 – August 2061
Interest rate swap guarantees
388,783
March 2022 – June 2025
465
The table below presents the fair value of our derivative financial instruments as well as their classification on the condensed consolidated balance sheets as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Fair Value of Derivatives
in an Asset Position (1) as of
in a Liability Position (2) as of
Interest rate contracts
42,491
14,385
1,219
614
Foreign exchange contracts
47,875
14,558
2,638
7,834
539
292
Total derivatives
39
The tables below present the effect of our derivative financial instruments on the condensed consolidated statements of operations for the three and six months ended June 30, 2020 and 2019 (amounts in thousands):
Amount of Gain (Loss)
Recognized in Income for the
Derivatives Not Designated
Location of Gain (Loss)
Three Months Ended June 30,
Six Months Ended June 30,
as Hedging Instruments
Recognized in Income
Loss on derivative financial instruments
(7,263)
(10,077)
(52,388)
(13,835)
70
(2,990)
(3,171)
(7,107)
13,245
46,158
15,689
(1,798)
(210)
447
(922)
13. Offsetting Assets and Liabilities
The following tables present the potential effects of netting arrangements on our financial position for financial assets and liabilities within the scope of ASC 210-20, Balance Sheet—Offsetting, which for us are derivative assets and liabilities as well as repurchase agreement liabilities (amounts in thousands):
(iv)
Gross Amounts Not
Offset in the Statement
(ii)
(iii) = (i) - (ii)
of Financial Position
Gross Amounts
Net Amounts
Cash
Offset in the
Presented in
Collateral
Statement of
the Statement of
Financial
Received /
(v) = (iii) - (iv)
Recognized
Financial Position
Instruments
Pledged
Net Amount
42,096
46,171
Repurchase agreements
4,894,579
4,893,337
5,312
14,208
9,423
3,136
4,618,197
4,614,769
14. Variable Interest Entities
Investment Securities
As discussed in Note 2, we evaluate all of our investments and other interests in entities for consolidation, including our investments in CMBS, RMBS and our retained interests in securitization transactions we initiated, all of which are generally considered to be variable interests in VIEs.
Securitization VIEs consolidated in accordance with ASC 810 are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. The assets and other instruments held by these securitization entities are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the securitization entities do not have any recourse to the general credit of any other consolidated entities, nor to us as the primary beneficiary. The VIE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities are eliminated, as is the interest income related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.
VIEs in which we are the Primary Beneficiary
The inclusion of the assets and liabilities of securitization VIEs in which we are deemed the primary beneficiary has no economic effect on us. Our exposure to the obligations of securitization VIEs is generally limited to our investment in these entities. We are not obligated to provide, nor have we provided, any financial support for any of these consolidated structures.
During the year ended December 31, 2019, we refinanced a pool of our commercial loans held-for-investment through a CLO, which is considered to be a VIE. We are the primary beneficiary of, and therefore consolidate, the CLO in our financial statements as we have both (i) the power to direct the activities in our role as collateral manager that most significantly impact the CLO’s economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the CLO that could be potentially significant through the subordinate interests we own.
The following table details the assets and liabilities of our consolidated CLO as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Loans held-for-investment
1,875
3,129
558
26,496
1,101,838
1,103,129
Liabilities
635
1,362
929,942
929,422
Assets held by this CLO are restricted and can be used only to settle obligations of the CLO, including the subordinate interests owned by us. The liabilities of this CLO are non-recourse to us and can only be satisfied from the assets of the CLO.
We also hold controlling interests in other non-securitization entities that are considered VIEs. SPT Dolphin Intermediate LLC (“SPT Dolphin”), the entity which holds the Woodstar II Portfolio, is a VIE because the third party interest holders do not carry kick-out rights or substantive participating rights. We were deemed to be the primary beneficiary of the VIE because we possess both the power to direct the activities of the VIE that most significantly impact its economic performance and a significant economic interest in the entity. This VIE had total assets of $677.1 million and liabilities of $445.9 million as of June 30, 2020.
In December 2019, we entered into a newly-formed joint venture (the “CMBS JV”) within our Investing and Servicing Segment, which is considered a VIE because the third party interest holder does not carry kick-out rights or substantive participating rights. We hold a 51% ownership interest and are deemed the primary beneficiary of the CMBS JV. This VIE had total assets of $330.3 million and liabilities of $85.2 million as of June 30, 2020. Refer to Note 16 for further discussion.
In total, our other consolidated non-securitization VIEs had total assets of $1.1 billion and liabilities of $585.1 million as of June 30, 2020.
VIEs in which we are not the Primary Beneficiary
In certain instances, we hold a variable interest in a VIE in the form of CMBS, but either (i) we are not appointed, or do not serve as, special servicer or servicing administrator or (ii) an unrelated third party has the rights to unilaterally remove us as special servicer without cause. In these instances, we do not have the power to direct activities that most significantly impact the VIE’s economic performance. In other cases, the variable interest we hold does not obligate us to absorb losses or provide us with the right to receive benefits from the VIE which could potentially be significant. For these structures, we are not deemed to be the primary beneficiary of the VIE, and we do not consolidate these VIEs.
41
As of June 30, 2020, four of our collateralized debt obligation (“CDO”) structures within our Investing and Servicing Segment were in default or imminent default, which, pursuant to the underlying indentures, changes the rights of the variable interest holders. Upon default of a CDO, the trustee or senior note holders are allowed to exercise certain rights, including liquidation of the collateral, which at that time, is the activity which would most significantly impact the CDO’s economic performance. Further, when the CDO is in default, the collateral administrator no longer has the option to purchase securities from the CDO. In cases where the CDO is in default and we do not have the ability to exercise rights which would most significantly impact the CDO’s economic performance, we do not consolidate the VIE. As of June 30, 2020, none of these CDO structures were consolidated.
As noted above, we are not obligated to provide, nor have we provided, any financial support for any of our securitization VIEs, whether or not we are deemed to be the primary beneficiary. As such, the risk associated with our involvement in these VIEs is limited to the carrying value of our investment in the entity. As of June 30, 2020, our maximum risk of loss related to securitization VIEs in which we were not the primary beneficiary was $23.5 million on a fair value basis.
As of June 30, 2020, the securitization VIEs which we do not consolidate had debt obligations to beneficial interest holders with unpaid principal balances, excluding the notional value of interest-only securities, of $4.1 billion. The corresponding assets are comprised primarily of commercial mortgage loans with unpaid principal balances corresponding to the amounts of the outstanding debt obligations.
We also hold passive non-controlling interests in certain unconsolidated entities that are considered VIEs. We are not the primary beneficiaries of these VIEs as we do not possess the power to direct the activities of the VIEs that most significantly impact their economic performance and therefore report our interests, which totaled $21.2 million as of June 30, 2020, within investment in unconsolidated entities on our condensed consolidated balance sheet. Our maximum risk of loss is limited to our carrying value of the investments.
15. Related-Party Transactions
Management Agreement
We are party to a management agreement (the “Management Agreement”) with our Manager. Under the Management Agreement, our Manager, subject to the oversight of our board of directors, is required to manage our day to day activities, for which our Manager receives a base management fee and is eligible for an incentive fee and stock awards. Our Manager’s personnel perform certain due diligence, legal, management and other services that outside professionals or consultants would otherwise perform. As such, in accordance with the terms of our Management Agreement, our Manager is paid or reimbursed for the documented costs of performing such tasks, provided that such costs and reimbursements are in amounts no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis. Refer to Note 16 to the consolidated financial statements included in our Form 10-K for further discussion of this agreement.
Base Management Fee. For the three months ended June 30, 2020 and 2019, approximately $19.1 million and $18.9 million, respectively, was incurred for base management fees. For the six months ended June 30, 2020 and 2019, approximately $38.2 million and $38.5 million, respectively, was incurred for base management fees. In April 2020, our board of directors authorized the payment of our first quarter base management fee of $19.1 million in 1,422,143 shares of our common stock. As of June 30, 2020 and December 31, 2019, there were $19.1 million and $19.3 million, respectively, of unpaid base management fees included in related-party payable in our condensed consolidated balance sheets.
Incentive Fee. There were no incentive fees incurred during the three months ended June 30, 2020 and 2019. For the six months ended June 30, 2020 and 2019, approximately $15.8 million and $0.2 million, respectively, was incurred for incentive fees. As of December 31, 2019, there were $18.1 million of unpaid incentive fees included in related-party payable in our condensed consolidated balance sheets. There were no unpaid incentive fees as of June 30, 2020.
Expense Reimbursement. For the three months ended June 30, 2020 and 2019, approximately $1.5 million and $1.7 million, respectively, was incurred for executive compensation and other reimbursable expenses and recognized within general and administrative expenses in our condensed consolidated statements of operations. For the six months
ended June 30, 2020 and 2019, approximately $3.7 million and $3.9 million, respectively, was incurred for executive compensation and other reimbursable expenses. As of June 30, 2020 and December 31, 2019, approximately $1.8 million and $3.5 million, respectively, of unpaid reimbursable executive compensation and other expenses were included in related-party payable in our condensed consolidated balance sheets.
Equity Awards. In certain instances, we issue RSAs to certain employees of affiliates of our Manager who perform services for us. During the three months ended June 30, 2019, we granted 68,645 RSAs at a grant date fair value of $1.5 million. There were no RSAs granted during the three months ended June 30, 2020. Expenses related to the vesting of awards to employees of affiliates of our Manager were $1.3 million and $1.0 million during the three months ended June 30, 2020 and 2019, respectively, and are reflected in general and administrative expenses in our condensed consolidated statements of operations. During the six months ended June 30, 2020 and 2019, we granted 341,635 and 182,861 RSAs, respectively, at grant date fair values of $3.9 million and $4.1 million, respectively. Expenses related to the vesting of awards to employees of affiliates of our Manager were $2.4 million and $1.8 million during the six months ended June 30, 2020 and 2019, respectively. These shares generally vest over a three-year period.
Manager Equity Plan
In May 2017, the Company’s shareholders approved the Starwood Property Trust, Inc. 2017 Manager Equity Plan (the “2017 Manager Equity Plan”), which replaced the Starwood Property Trust, Inc. Manager Equity Plan (“Manager Equity Plan”). In September 2019, we granted 1,200,000 RSUs to our Manager under the 2017 Manager Equity Plan. In April 2018, we granted 775,000 RSUs to our Manager under the 2017 Manager Equity Plan. In March 2017, we granted 1,000,000 RSUs to our Manager under the Manager Equity Plan. In connection with these grants and prior similar grants, we recognized share-based compensation expense of $3.4 million and $3.2 million within management fees in our condensed consolidated statements of operations for the three months ended June 30, 2020 and 2019, respectively. For the six months ended June 30, 2020 and 2019, we recognized $8.6 million and $6.4 million, respectively, related to these awards. Refer to Note 16 for further discussion of these grants.
Investments in Loans
In January 2020, the Company originated a $3.5 million bridge loan to a third party borrower for the development and recapitalization of luxury cabin rentals. In February 2020, the bridge loan was repaid, and the Company originated a $99.0 million first mortgage loan to the same borrower. The loan bears interest at a fixed rate of 10.5% plus fees and contains a term of 36 months with two one-year extension options. Certain members of our executive team and board of directors own equity interests in the borrower. The investment was approved by our independent directors.
In January 2020, the Company co-originated a €70.3 million mezzanine loan with SEREF, an affiliate of our Manager, to the third party that acquired our property portfolio in Ireland in December 2019. The Company and SEREF each originated €35.2 million. The loan matures in October 2025.
During the three and six months ended June 30, 2020, the Company acquired $26.6 million and $127.4 million, respectively, of loans from a residential mortgage originator in which it holds an equity interest. Refer to Note 7 for further discussion.
Lease Arrangements
In March 2020, we entered into an office lease agreement with an entity which is controlled by our Chairman and CEO through majority equity ownership of the entity. The leased premises are currently under construction and will serve as our new Miami Beach office when our existing lease in Miami Beach expires on December 31, 2021. The lease will commence after delivery of the office space to us, but no earlier than July 30, 2021. The lease is for approximately 74,000 square feet of office space, has an initial term of 15 years and requires monthly lease payments starting in the tenth month after lease commencement. The lease payments are based on an annual base rate of $52.00 per square foot that increases by 3% each anniversary following commencement, plus our pro rata share of building operating expenses. In April 2020, we provided a $1.9 million cash security deposit to the landlord. Prior to the execution of this lease, we engaged an independent third party leasing firm and external counsel to advise the independent directors of our board of directors on market terms for the lease. The terms of the lease were approved by our independent directors.
43
Other Related-Party Arrangements
Highmark Residential (“Highmark”), an affiliate of our Manager, provides property management services for 21 properties within our Woodstar I Portfolio. Fees paid to Highmark are calculated as a percentage of gross receipts and are at market terms. During the three months ended June 30, 2020 and 2019, property management fees to Highmark of $0.5 million and $0.4 million, respectively, were recognized in our condensed consolidated statements of operations. During the six months ended June 30, 2020 and 2019, property management fees to Highmark of $1.0 million and $0.7 million, respectively, were recognized in our condensed consolidated statements of operations.
Refer to Note 16 to the consolidated financial statements included in our Form 10-K for further discussion of related-party agreements.
16. Stockholders’ Equity and Non-Controlling Interests
During the six months ended June 30, 2020, our board of directors declared the following dividends:
Declaration Date
Record Date
Ex-Dividend Date
Payment Date
Frequency
6/16/20
6/30/20
6/29/20
7/15/20
0.48
Quarterly
2/25/20
3/31/20
3/30/20
4/15/20
During the six months ended June 30, 2020 and 2019, there were no shares issued under our At-The-Market Equity Offering Sales Agreement. During the six months ended June 30, 2020 and 2019, shares issued under the Starwood Property Trust, Inc. Dividend Reinvestment and Direct Stock Purchase Plan (the “DRIP Plan”) were not material.
In February 2020, our board of directors authorized the repurchase of up to $400.0 million of our outstanding common shares and Convertible Notes over a period of one year. Purchases made pursuant to the program will be made either in the open market or in privately negotiated transactions from time to time as permitted by federal securities laws and other legal requirements. The timing, manner, price and amount of any repurchases are discretionary and will be subject to economic and market conditions, stock price, applicable legal requirements and other factors. The program may be suspended or discontinued at any time. During the six months ended June 30, 2020, we repurchased 1,925,421 shares of common stock for $28.8 million and no Convertible Notes under our repurchase program. As of June 30, 2020, we had $371.2 million of remaining capacity to repurchase common stock and/or Convertible Notes under the repurchase program.
Equity Incentive Plans
In May 2017, the Company’s shareholders approved the 2017 Manager Equity Plan and the Starwood Property Trust, Inc. 2017 Equity Plan (the “2017 Equity Plan”), which allow for the issuance of up to 11,000,000 stock options, stock appreciation rights, RSAs, RSUs or other equity-based awards or any combination thereof to the Manager, directors, employees, consultants or any other party providing services to the Company. The 2017 Manager Equity Plan succeeds and replaces the Manager Equity Plan and the 2017 Equity Plan succeeds and replaces the Starwood Property Trust, Inc. Equity Plan (the “Equity Plan”) and the Starwood Property Trust, Inc. Non-Executive Director Stock Plan (the “Non-Executive Director Stock Plan”).
The table below summarizes our share awards granted or vested under the Manager Equity Plan and the 2017 Manager Equity Plan during the six months ended June 30, 2020 and 2019 (dollar amounts in thousands):
Grant Date
Type
Amount Granted
Grant Date Fair Value
Vesting Period
September 2019
RSU
1,200,000
29,484
April 2018
775,000
16,329
3 years
March 2017
1,000,000
22,240
Schedule of Non-Vested Shares and Share Equivalents
Manager
Grant Date Fair
Equity Plan
Value (per share)
1,413,170
1,305,597
2,718,767
22.74
Granted
965,847
10.77
Vested
(474,367)
(376,017)
(850,384)
22.40
Forfeited
(5,647)
14.69
1,899,003
929,580
2,828,583
18.77
As of June 30, 2020, there were 6.5 million shares of common stock available for future grants under the 2017 Manager Equity Plan and the 2017 Equity Plan.
Non-Controlling Interests in Consolidated Subsidiaries
In connection with our Woodstar II Portfolio acquisitions, we issued 10.2 million Class A Units in our consolidated subsidiary, SPT Dolphin, and rights to receive an additional 1.9 million Class A Units if certain contingent events occur. As of June 30, 2020, 1.8 million of the 1.9 million contingent Class A Units were issued. The Class A Units are redeemable for consideration equal to the current share price of the Company’s common stock on a one-for-one basis, with the consideration paid in either cash or the Company’s common stock, at the determination of the Company. During the six months ended June 30, 2020, redemptions of 0.4 million of the Class A Units were received and settled in common stock, leaving 10.6 million Class A Units outstanding as of June 30, 2020. There were no redemptions of the Class A units during the three months ended June 30, 2020. In consolidation, the outstanding Class A Units are reflected as non-controlling interests in consolidated subsidiaries on our condensed consolidated balance sheets, the balance of which was $227.1 million and $235.9 million as of June 30, 2020 and December 31, 2019, respectively.
To the extent SPT Dolphin has sufficient cash available, the Class A Units earn a preferred return indexed to the dividend rate of the Company’s common stock. Any distributions made pursuant to this waterfall are recognized within net income attributable to non-controlling interests in our condensed consolidated statements of operations. During the three and six months ended June 30, 2020, we recognized net income attributable to non-controlling interests of $5.1 million and $10.2 million, respectively, associated with these Class A Units. During the three and six months ended June 30, 2019, we recognized net income attributable to non-controlling interests of $5.4 million and $11.1 million, respectively, associated with these Class A Units.
As discussed in Note 14, we entered into the CMBS JV within our Investing and Servicing Segment in December 2019. Because the CMBS JV was deemed a VIE for which we were the primary beneficiary, this transaction was not recognized as a sale for GAAP purposes. Instead, the 49% interest of our joint venture partner is reflected as a non-controlling interest in consolidated subsidiaries on our consolidated balance sheets, and any net income attributable to this 49% joint venture interest is reflected within net income attributable to non-controlling interests in our consolidated statement of operations. The non-controlling interests in the CMBS JV were $126.4 million and $175.6 million as of June 30, 2020 and December 31, 2019, respectively. During the three and six months ended June 30, 2020, net income attributable to non-controlling interests was $6.8 million and $0.8 million, respectively.
17. Earnings per Share
The following table provides a reconciliation of net income and the number of shares of common stock used in the computation of basic EPS and diluted EPS (amounts in thousands, except per share amounts):
Basic Earnings
Income attributable to STWD common stockholders
Less: Income attributable to participating shares not already deducted as non-controlling interests
(1,143)
(751)
(2,365)
(1,575)
Basic earnings
138,513
126,265
70,522
195,824
Diluted Earnings
Add: Interest expense on Convertible Notes (1)
3,051
3,049
*
6,235
Add: Undistributed earnings to participating shares
120
Less: Undistributed earnings reallocated to participating shares
(116)
Diluted earnings
141,568
129,314
202,059
Number of Shares:
Basic — Average shares outstanding
281,461
279,239
281,225
278,396
Effect of dilutive securities — Convertible Notes (1)
9,649
9,963
Effect of dilutive securities — Unvested non-participating shares
183
184
215
170
Diluted — Average shares outstanding
291,293
289,072
281,440
288,529
Earnings Per Share Attributable to STWD Common Stockholders:
* Our Convertible Notes were not dilutive for the six months ended June 30, 2020.
As of June 30, 2020 and 2019, participating shares of 13.0 million and 12.8 million, respectively, were excluded from the computation of diluted shares as their effect was already considered under the more dilutive two-class method used above. Such participating shares at June 30, 2020 and 2019 included 10.6 million and 11.2 million potential shares, respectively, of our common stock issuable upon redemption of the Class A Units in SPT Dolphin, as discussed in Note 16.
18. Accumulated Other Comprehensive Income
The changes in AOCI by component are as follows (amounts in thousands):
Cumulative
Unrealized Gain
(Loss) on
Foreign
Available-for-
Currency
Sale Securities
Translation
Balance at April 1, 2020
35,948
(64)
OCI before reclassifications
Amounts reclassified from AOCI
Net period OCI
Balance at April 1, 2019
53,128
2,670
53,049
4,075
Balance at January 1, 2020
Balance at January 1, 2019
53,515
5,145
19. Fair Value
GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:
Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Valuation Process
We have valuation control processes in place to validate the fair value of the Company’s financial assets and liabilities measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and the assumptions are reasonable.
Pricing Verification—We use recently executed transactions, other observable market data such as exchange data, broker/dealer quotes, third party pricing vendors and aggregation services for validating the fair values generated using valuation models. Pricing data provided by approved external sources is evaluated using a number of approaches; for example, by corroborating the external sources’ prices to executed trades, analyzing the methodology and assumptions used by the external source to generate a price and/or by evaluating how active the third party pricing source (or originating sources used by the third party pricing source) is in the market.
Unobservable Inputs—Where inputs are not observable, we review the appropriateness of the proposed valuation methodology to ensure it is consistent with how a market participant would arrive at the unobservable input. The valuation methodologies utilized in the absence of observable inputs may include extrapolation techniques and the use of comparable observable inputs.
Any changes to the valuation methodology will be reviewed by our management to ensure the changes are appropriate. The methods used may produce a fair value calculation that is not indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value could result in a different estimate of fair value at the reporting date.
Fair Value on a Recurring Basis
We determine the fair value of our financial assets and liabilities measured at fair value on a recurring basis as follows:
Loans held-for-sale, commercial
We measure the fair value of our commercial mortgage loans held-for-sale using a discounted cash flow analysis unless observable market data (i.e., securitized pricing) is available. A discounted cash flow analysis requires management to make estimates regarding future interest rates and credit spreads. The most significant of these inputs relates to credit spreads and is unobservable. Thus, we have determined that the fair values of mortgage loans valued using a discounted cash flow analysis should be classified in Level III of the fair value hierarchy, while mortgage loans
valued using securitized pricing should be classified in Level II of the fair value hierarchy. Mortgage loans classified in Level III are transferred to Level II if securitized pricing becomes available.
Loans held-for-sale and loans held-for-investment, residential
We measure the fair value of our residential mortgage loans held-for-sale and held-for-investment based on the net present value of expected future cash flows using a combination of observable and unobservable inputs. Observable market participant assumptions include pricing related to trades of residential mortgage loans with similar characteristics. Unobservable inputs include the expectation of future cash flows, which involves judgments about the underlying collateral, the creditworthiness of the borrower, estimated prepayment speeds, estimated future credit losses, forward interest rates, investor yield requirements and certain other factors. At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value. However, given the significance of the unobservable inputs, these loans have been classified within Level III.
RMBS are valued utilizing observable and unobservable market inputs. The observable market inputs include recent transactions, broker quotes and vendor prices (“market data”). However, given the implied price dispersion amongst the market data, the fair value determination for RMBS has also utilized significant unobservable inputs in discounted cash flow models including prepayments, default and severity estimates based on the recent performance of the collateral, the underlying collateral characteristics, industry trends, as well as expectations of macroeconomic events (e.g., housing price curves, interest rate curves, etc.). At each measurement date, we consider both the observable and unobservable valuation inputs in the determination of fair value. However, given the significance of the unobservable inputs these securities have been classified within Level III.
CMBS are valued utilizing both observable and unobservable market inputs. These factors include projected future cash flows, ratings, subordination levels, vintage, remaining lives, credit issues, recent trades of similar securities and the spreads used in the prior valuation. We obtain current market spread information where available and use this information in evaluating and validating the market price of all CMBS. Depending upon the significance of the fair value inputs used in determining these fair values, these securities are classified in either Level II or Level III of the fair value hierarchy. CMBS may shift between Level II and Level III of the fair value hierarchy if the significant fair value inputs used to price the CMBS become or cease to be observable.
Equity security
The equity security is publicly registered and traded in the U.S. and its market price is listed on the London Stock Exchange. The security has been classified within Level I.
Domestic servicing rights
The fair value of this intangible is determined using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, including forecasted loan defeasance, control migration, delinquency and anticipated maturity defaults which are calculated assuming a debt yield at which default occurs. Since the most significant of these inputs are unobservable, we have determined that the fair values of this intangible in its entirety should be classified in Level III of the fair value hierarchy.
Derivatives
The valuation of derivative contracts are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market based inputs, including interest rate curves, spot and market forward points and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted
49
expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
We incorporate credit valuation adjustments to appropriately reflect both our own non-performance risk and the respective counterparty’s non-performance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of non-performance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
The valuation of over the counter derivatives are determined using discounted cash flows based on Overnight Index Swap (“OIS”) rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs (i.e., a LIBOR OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk. For credit index instruments, fair value is determined based on changes in the relevant indices from the date of initiation of the instrument to the reporting date, as these changes determine the amount of any future cash settlement between us and the counterparty. These indices are considered Level II inputs as they are directly observable.
Although we have determined that the majority of the inputs used to value our derivatives fall within Level II of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level III inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties. However, as of June 30, 2020 and December 31, 2019, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we have determined that our derivative valuations in their entirety are classified in Level II of the fair value hierarchy.
Liabilities of consolidated VIEs
Our consolidated VIE liabilities generally represent bonds that are not owned by us. The majority of these are either traded in the marketplace or can be analogized to similar securities that are traded in the marketplace. For these liabilities, pricing is considered to be Level II, where the valuation is based upon quoted prices for similar instruments traded in active markets. We generally utilize third party pricing service providers for valuing these liabilities. In order to determine whether to utilize the valuations provided by third parties, we conduct an ongoing evaluation of their valuation methodologies and processes, as well as a review of the individual valuations themselves. In evaluating third party pricing for reasonableness, we consider a variety of factors, including market transaction information for the particular bond, market transaction information for bonds within the same trust, market transaction information for similar bonds, the bond’s ratings and the bond’s subordination levels.
For the minority portion of our consolidated VIE liabilities which consist of unrated or non-investment grade bonds that are not owned by us, pricing may be either Level II or Level III. If independent third party pricing similar to that noted above is available, we consider the valuation to be Level II. If such third party pricing is not available, the valuation is generated from model-based techniques that use significant unobservable assumptions, and we consider the valuation to be Level III. For VIE liabilities classified as Level III, valuation is determined based on discounted expected future cash flows which take into consideration expected duration and yields based on market transaction information, ratings, subordination levels, vintage and current market spread. VIE liabilities may shift between Level II and Level III of the fair value hierarchy if the significant fair value inputs used to price the VIE liabilities become or cease to be observable.
Assets of consolidated VIEs
The securitization VIEs in which we invest are “static”; that is, no reinvestment is permitted, and there is no active management of the underlying assets. In determining the fair value of the assets of the VIE, we maximize the use of observable inputs over unobservable inputs. The individual assets of a VIE are inherently incapable of precise measurement given their illiquid nature and the limitations on available information related to these assets. Because our methodology for valuing these assets does not value the individual assets of a VIE, but rather uses the value of the VIE
50
liabilities as an indicator of the fair value of VIE assets as a whole, we have determined that our valuations of VIE assets in their entirety should be classified in Level III of the fair value hierarchy.
Fair Value on a Nonrecurring Basis
We determine the fair value of our financial assets and liabilities measured at fair value on a nonrecurring basis as follows:
Loans held-for-sale, infrastructure
We measure the fair value of infrastructure loans held-for-sale, which are carried at the lower of amortized cost or fair value, utilizing bids periodically received from third parties to acquire these assets. As these bids represent observable market data, we have determined that the fair value of these assets would be classified in Level II of the fair value hierarchy.
Fair Value Only Disclosed
We determine the fair value of our financial instruments and assets where fair value is disclosed as follows:
Loans held-for-investment and loans held-for-sale
We estimate the fair values of our loans not carried at fair value on a recurring basis by discounting their expected cash flows at a rate we estimate would be demanded by the market participants that are most likely to buy our loans. The expected cash flows used are generally the same as those used to calculate our level yield income in the financial statements. Since these inputs are unobservable, we have determined that the fair value of these loans in their entirety would be classified in Level III of the fair value hierarchy.
HTM debt securities
We estimate the fair value of our mandatorily redeemable preferred equity interests in commercial real estate companies and infrastructure bonds using the same methodology described for our loans held-for-investment. We estimate the fair value of our HTM CMBS using the same methodology described for our CMBS carried at fair value on a recurring basis.
Secured financing agreements, CLO and unsecured senior notes not convertible
The fair value of the secured financing agreements, CLO and unsecured senior notes not convertible are determined by discounting the contractual cash flows at the interest rate we estimate such arrangements would bear if executed in the current market. We have determined that our valuation of these instruments should be classified in Level III of the fair value hierarchy.
Convertible Notes
The fair value of the debt component of our Convertible Notes is estimated by discounting the contractual cash flows at the interest rate we estimate such notes would bear if sold in the current market without the embedded conversion option which, in accordance with ASC 470, is reflected as a component of equity. We have determined that our valuation of our Convertible Notes should be classified in Level III of the fair value hierarchy.
51
Fair Value Disclosures
The following tables present our financial assets and liabilities carried at fair value on a recurring basis in the condensed consolidated balance sheets by their level in the fair value hierarchy as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Level I
Level II
Level III
Financial Assets:
Loans under fair value option
894,613
23,530
1,639
VIE assets
65,382,462
92,544
65,280,127
Financial Liabilities:
VIE liabilities
60,488,446
2,129,529
62,621,855
60,492,326
1,436,194
37,360
12,352
25,008
63,908,829
41,295
63,854,870
58,206,102
2,537,392
60,752,234
58,214,842
52
The changes in financial assets and liabilities classified as Level III are as follows for the three and six months ended June 30, 2020 and 2019 (amounts in thousands):
Loans at
VIE
VIE Assets
April 1, 2020 balance
1,347,797
170,640
22,435
16,524
61,157,805
(1,506,437)
61,208,764
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale
(351)
2,417,647
(8,686)
2,440,491
Net accretion
2,673
Included in OCI
Purchases / Originations
140,700
(589,694)
Cash repayments / receipts
(38,640)
(6,014)
(193)
(344)
(45,191)
Transfers into Level III
(655,942)
Transfers out of Level III
41,880
Consolidation of VIEs
599,935
June 30, 2020 balance
(2,129,529)
63,150,598
Amount of unrealized gains (losses) attributable to assets still held at June 30, 2020:
Included in earnings
20,349
2,429,063
April 1, 2019 balance
841,687
204,835
38,335
19,790
56,974,864
(2,046,559)
56,032,952
1,016
126,589
3,492
152,072
2,535
911,938
(367,045)
(750)
(367,795)
Issuances
(25,045)
(36,073)
(6,417)
(5,402)
(2,881)
(50,773)
(594,399)
294,227
824,070
(4,541)
819,529
Deconsolidation of VIEs
1,084
(257,917)
1,704
(255,129)
June 30, 2019 balance
1,372,398
200,874
34,283
18,874
57,667,606
(2,374,002)
56,920,033
Amount of unrealized gains (losses) included in earnings attributable to assets still held at June 30, 2019
5,547
410
137,657
53
January 1, 2020 balance
(2,537,392)
61,317,478
5,387
(1,089,145)
137,596
(930,808)
5,334
887,580
(1,341,440)
(7,940)
(1,349,380)
(106,037)
(12,563)
(564)
(9,260)
(128,424)
(757,207)
1,132,205
(71,095)
3,006,262
1,589
(999)
(948,587)
January 1, 2019 balance
671,282
209,079
25,228
20,557
53,446,364
(1,441,446)
52,931,064
721
420,934
37,449
490,578
5,038
1,652,234
(928,747)
(3,978)
(932,725)
(58,723)
(55,528)
(12,777)
(5,590)
(3,270)
(77,165)
5,350
(1,265,141)
(1,259,791)
430,819
(107,850)
3,996,285
12,552
(303,827)
34,160
(257,115)
Amount of total gains (losses) included in earnings attributable to assets still held at June 30, 2019
(157)
466,726
Amounts were transferred from Level II to Level III due to a decrease in the observable relevant market activity and amounts were transferred from Level III to Level II due to an increase in the observable relevant market activity.
The following table presents the fair values, all of which are classified in Level III of the fair value hierarchy, of our financial instruments not carried at fair value on the condensed consolidated balance sheets (amounts in thousands):
Fair
Financial assets not carried at fair value:
10,197,948
10,096,859
10,034,030
10,086,372
Financial liabilities not carried at fair value:
Secured financing agreements and CLO
9,765,627
9,663,737
9,834,108
9,826,511
Unsecured senior notes
1,873,867
2,022,283
54
The following is quantitative information about significant unobservable inputs in our Level III measurements for those assets and liabilities measured at fair value on a recurring basis (dollars in thousands):
Valuation
Unobservable
Range (Weighted Average) as of (1)
Technique
Input
Discounted cash flow
Yield (b)
2.9% - 8.9% (4.8%)
3.4% - 5.9%
Duration (c)
1.5 - 11.2 years (5.1 years)
1.3 - 11.3 years
Constant prepayment rate (a)
3.2% - 16.4% (7.3%)
3.1% - 24.9%
Constant default rate (b)
1.3% - 5.0% (2.6%)
0.5% - 5.0%
Loss severity (b)
0% - 79% (27%) (e)
0% - 93% (e)
Delinquency rate (c)
8% - 28% (18%)
5% - 29%
Servicer advances (a)
24% - 85% (61%)
27% - 85%
Annual coupon deterioration (b)
0% - 0.9% (0.1%)
0% - 1.6%
Putback amount per projected total collateral loss (d)
0% - 25% (2.7%)
0% - 28%
0% - 180.5% (5.5%)
0% - 122.9%
0 - 6.7 years (3.5 years)
0 - 9.7 years
Debt yield (a)
7.75% (7.75%)
7.50%
Discount rate (b)
15% (15%)
15%
0% - 866.4% (14.5%)
0% - 690.7%
0 - 18.1 years (4.1 years)
0 - 19.2 years
0% - 866.4% (14.6%)
0 - 11.3 years (4.1 years)
0 - 12.7 years
Information about Uncertainty of Fair Value Measurements
20. Income Taxes
Certain of our domestic subsidiaries have elected to be treated as taxable REIT subsidiaries (“TRSs”). TRSs permit us to participate in certain activities from which REITs are generally precluded, as long as these activities meet specific criteria, are conducted within the parameters of certain limitations established by the Code and are conducted in entities which elect to be treated as taxable subsidiaries under the Code. To the extent these criteria are met, we will continue to maintain our qualification as a REIT.
Our TRSs engage in various real estate related operations, including special servicing of commercial real estate, originating and securitizing commercial mortgage loans, and investing in entities which engage in real estate-related operations. As of June 30, 2020 and December 31, 2019, approximately $1.0 billion and $1.6 billion, respectively, of assets were owned by TRS entities. Our TRSs are not consolidated for U.S. federal income tax purposes, but are instead taxed as corporations. For financial reporting purposes, a provision for current and deferred taxes is established for the portion of earnings recognized by us with respect to our interest in TRSs.
The following table is a reconciliation of our U.S. federal income tax (benefit) provision determined using our statutory federal tax rate to our reported income tax (benefit) provision for the three and six months ended June 30, 2020 and 2019 (dollars in thousands):
Federal statutory tax rate
31,849
21.0
28,556
16,520
44,692
REIT and other non-taxable loss
(26,923)
(17.8)
(26,013)
(19.1)
(17,009)
(21.6)
(42,172)
(19.8)
State income taxes
1,619
1.1
666
0.5
(160)
(0.2)
660
0.3
Federal benefit of state tax deduction
(340)
(140)
(0.1)
(139)
Net operating loss carryback rate differential
(3,717)
(2.5)
(4.7)
Intra-entity transfer
(3,781)
(4.8)
(5)
464
86
0.1
826
0.4
Effective tax rate
(1,298)
(0.9)
3,533
2.6
(8,027)
(10.2)
3,867
1.8
The Company has used the discrete tax approach in calculating the tax benefit for the three and six months ended June 30, 2020 due to the fact that a relatively small change in the Company’s projected pre-tax net income could result in a volatile effective tax rate. Under the discrete method, the Company determines its tax benefit based upon actual results as if the interim period was an annual period.
In response to the COVID-19 pandemic, the U.S. and many other governments have enacted, or are contemplating enacting, measures to provide aid and economic stimulus. These measures include deferring the due dates of tax payments and other changes to their income and non-income-based tax laws. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was enacted on March 27, 2020 in the U.S., includes measures to assist companies, including temporary changes to income and non-income-based tax laws, and to allow companies to carry back tax net operating losses (“NOLs”) generated in 2018 to 2020 to the five preceding tax years. The Company plans to carry back its NOL generated this year to a year in which the federal tax rate was 35%, resulting in a tax benefit from the NOL carryback for the three and six months ended June 30, 2020. We continue to monitor additional guidance issued by the U.S. Treasury Department, the Internal Revenue Service and others.
56
21. Commitments and Contingencies
As of June 30, 2020, our Commercial and Residential Lending Segment had future commercial loan funding commitments totaling $2.0 billion, of which we expect to fund $1.9 billion. These future funding commitments primarily relate to construction projects, capital improvements, tenant improvements and leasing commissions.
During the three months ended June 30, 2020, we entered into a trade confirmation which would allow us to acquire $557.9 million unpaid principal balance of residential loans at a discount to the par amount of the loans. The closing date on all or a portion of these loans will be as mutually agreed between us and the seller.
As of June 30, 2020, our Infrastructure Lending Segment had future infrastructure loan funding commitments totaling $272.7 million, including $139.8 million under revolvers and letters of credit (“LCs”), and $132.9 million under delayed draw term loans. As of June 30, 2020, $24.9 million of revolvers and LCs were outstanding.
In connection with the Infrastructure Lending Segment acquisition, we assumed guarantees of certain borrowers’ performance under existing interest rate swaps. As of June 30, 2020, we had six outstanding guarantees on interest rate swaps maturing between March 2022 and June 2025. Refer to Note 12 for further discussion.
Generally, funding commitments are subject to certain conditions that must be met, such as customary construction draw certifications, minimum debt service coverage ratios or executions of new leases before advances are made to the borrower.
Management is not aware of any other contractual obligations, legal proceedings, or any other contingent obligations incurred in the normal course of business that would have a material adverse effect on our condensed consolidated financial statements.
As of June 30, 2020, no contingencies have been recorded on our consolidated balance sheet as a result of COVID-19. However, if the global pandemic continues and the economic implications worsen, it may have long-term impacts on our financial condition, results of operations, and cash flows. Refer to Note 2 for further discussion of COVID-19.
22. Segment Data
In its operation of the business, management, including our chief operating decision maker, who is our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis prior to the impact of consolidating securitization VIEs under ASC 810. The segment information within this Note is reported on that basis.
The table below presents our results of operations for the three months ended June 30, 2020 by business segment (amounts in thousands):
Commercial and
Investing
Lending
and Servicing
Segment
Corporate
Subtotal
VIEs
150,136
19,126
17,345
683
24,924
42,952
(28,308)
142
8,591
8,733
(2,075)
690
63,566
8,454
100
280
492
168,367
19,909
63,624
44,090
295,990
(30,384)
339
220
22,554
23,113
41,871
9,678
15,942
6,177
27,825
8,615
4,337
1,281
14,993
3,368
32,594
83
578
1,100
(88)
988
24,703
3,941
430
89
19,153
3,749
11,294
(1,092)
76
64,191
14,112
61,105
28,992
53,747
222,147
85
5,328
(7,897)
5,454
7,941
13,395
(12,568)
33,010
1,440
671
(1,118)
29,526
29,079
(303)
(Loss) gain on sale of investments and other assets, net
(961)
7,433
(Loss) gain on derivative financial instruments, net
(11,736)
(437)
(4,614)
(3,828)
4,517
6,942
310
(48)
(31)
(22)
(2,185)
Other income, net
191
Total other income (loss)
33,358
(1,245)
(6,656)
47,822
77,796
30,493
Income (loss) before income taxes
137,534
4,552
(4,137)
62,920
(49,230)
151,639
Income tax (provision) benefit
(3,257)
(56)
4,611
Net income (loss)
134,277
67,531
152,937
(4)
(5,111)
(8,166)
(13,281)
(24)
Net income (loss) attributable to Starwood Property Trust, Inc.
134,273
(9,248)
59,365
The table below presents our results of operations for the three months ended June 30, 2019 by business segment (amounts in thousands):
163,071
25,291
3,104
24,367
868
31,163
56,398
(33,853)
90
15,880
15,970
(6,962)
72,326
14,971
252
88
515
187,780
26,166
72,414
65,633
351,999
(40,818)
353
22,107
22,478
58,564
16,258
19,132
8,515
27,821
130,290
(164)
6,754
4,830
1,706
20,177
4,019
37,486
92
160
(100)
741
23,125
6,789
285
23,076
5,191
2,096
422
194
69,029
21,524
68,212
40,784
53,947
253,496
(27)
(1,159)
243
(948)
15,815
14,867
(14,200)
5,363
16,528
Earnings from unconsolidated entities
5,492
1,044
2,754
9,290
(473)
239
2,276
Gain (loss) on derivative financial instruments, net
5,592
(2,833)
(11,147)
(6,953)
15,309
Foreign currency (loss) gain, net
(6,927)
(83)
8,811
(3,456)
(10,111)
26,986
37,539
40,728
127,562
1,186
(5,909)
51,835
(38,632)
136,042
(63)
(1,832)
186
(1,887)
125,730
1,372
49,948
132,509
(21)
(5,355)
(117)
(5,493)
63
125,709
(11,264)
49,831
59
The table below presents our results of operations for the six months ended June 30, 2020 by business segment (amounts in thousands):
342,517
41,539
4,474
35,973
1,384
49,724
87,081
(57,197)
314
15,033
15,347
(3,896)
768
127,527
18,561
232
180
793
1,448
379,804
43,166
127,707
88,585
639,262
(61,096)
459
62,661
63,810
95,821
22,795
33,063
13,371
56,630
221,680
(162)
16,747
8,760
2,359
35,677
71,212
167
1,438
1,117
(68)
1,766
47,555
8,525
845
159
38,441
7,956
51,511
7,360
153
337
168,971
40,191
121,767
65,920
126,960
523,809
5,646
(8,608)
(22,425)
(39,275)
(61,700)
65,031
(2,507)
20,823
722
30,146
29,750
(877)
296
19,069
(1,438)
(34,837)
(22,934)
33,752
(27,059)
(163)
(67)
241
Total other (loss) income
(33,183)
(2,593)
(36,848)
1,904
(36,968)
61,314
177,650
382
(30,908)
24,569
(93,208)
78,485
Income tax benefit
1,165
6,773
178,815
471
31,342
86,512
(7)
(10,222)
(3,396)
(13,625)
(180)
178,808
(41,130)
27,946
60
The table below presents our results of operations for the six months ended June 30, 2019 by business segment (amounts in thousands):
317,666
52,206
5,010
44,275
1,753
55,456
101,484
(61,307)
213
43,123
43,336
(9,895)
142,847
28,283
456
693
166
711
2,052
362,610
54,652
143,013
132,583
692,884
(71,223)
764
45,095
45,895
94
120,168
34,835
38,122
16,261
55,736
265,122
(324)
13,522
9,309
3,224
39,028
7,245
72,328
409
(23)
760
46,062
13,484
356
46,972
10,478
2,085
1,196
1,307
138,217
45,370
135,687
79,458
108,076
506,808
(50)
(1,674)
(9)
(2,642)
33,955
31,313
(30,584)
6,749
26,408
6,069
(42,761)
3,348
(33,344)
(1,039)
2,994
3,066
940
(3,705)
(3,228)
(9,857)
(10,385)
24,936
(1,688)
217
(Loss) gain on extinguishment of debt
(6,120)
Other loss, net
7,777
(6,065)
(52,617)
52,592
24,869
26,556
71,362
232,170
3,217
(45,291)
105,717
(83,181)
212,632
189
(1,584)
271
(258)
(2,296)
230,586
3,488
(45,549)
103,421
208,765
Net (income) loss attributable to non-controlling interests
(392)
(11,072)
98
(11,366)
(189)
230,194
(56,621)
103,519
61
The table below presents our condensed consolidated balance sheet as of June 30, 2020 by business segment (amounts in thousands):
13,959
299
30,237
35,855
266,333
346,683
1,051
114,656
7,537
20,044
Loans held-for-investment, net
8,960,410
1,153
44,876
Investment securities
1,120,624
1,094,613
27,283
1,998,759
198,281
Intangible assets
43,580
67,567
111,147
(34,854)
49,853
47,114
121,711
(16,798)
119,409
140,437
348
586
55,877
3,163
520
13,589
73,149
(1,401)
29,864
5,616
81,859
57,321
9,512
184,172
(25)
VIE assets, at fair value
10,853,187
1,731,818
2,162,320
1,857,588
331,530
16,936,443
62,619,836
27,941
10,285
45,277
36,400
91,765
211,668
20,936
2,260
1,620
4,749,321
1,221,001
1,792,818
683,466
389,714
5,708,829
1,232,906
1,838,095
719,871
2,573,753
12,073,454
62,618,029
1,473,921
504,262
137,777
(228,654)
3,306,266
Treasury stock
Accumulated other comprehensive income (loss)
Retained earnings (accumulated deficit)
3,627,392
(5,350)
(40,699)
1,222,945
(5,418,381)
5,144,243
498,912
97,078
994,227
(2,242,223)
115
227,147
143,490
370,752
1,807
5,144,358
324,225
1,137,717
4,862,989
62
The table below presents our condensed consolidated balance sheet as of December 31, 2019 by business segment (amounts in thousands):
26,278
2,209
30,123
61,693
356,864
477,167
1,221
36,135
41,967
7,171
10,370
9,187,332
1,294
119,528
992,974
1,177,148
26,834
2,029,024
210,582
47,303
64,644
111,947
(26,247)
46,921
32,183
104,966
(20,637)
14,718
45,996
3,134
133
2,388
13,242
64,893
(806)
59,170
6,101
82,910
54,238
8,911
211,330
11,041,742
1,760,818
2,196,667
1,914,222
393,225
17,306,674
60,735,662
30,594
6,443
48,370
73,021
53,494
211,922
84
40,920
7,698
5,038,876
1,217,066
1,698,334
574,507
391,215
8,919,998
(13,950)
6,005,228
1,224,259
1,746,704
647,825
2,551,678
12,175,694
60,729,628
1,522,360
529,668
208,650
(123,210)
2,995,064
3,463,158
5,431
1,194,998
(5,052,197)
5,036,514
536,559
214,081
1,071,724
(2,158,453)
235,882
194,673
430,555
6,034
449,963
1,266,397
5,130,980
23. Subsequent Events
Our significant events subsequent to June 30, 2020 were as follows:
Commercial Mortgage Loan Securitization
In July 2020, we securitized commercial mortgage loans held-for-sale with a principal balance of $151.3 million.
In July 2020, we amended the Infrastructure Loans repurchase facility with a maximum facility size of $500.0 million to extend the current maturity from February 2021 to February 2022.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with the information included elsewhere in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (our “Form 10-K”). This discussion contains forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from the results discussed in the forward-looking statements. See “Special Note Regarding Forward-Looking Statements” at the beginning of this Quarterly Report on Form 10-Q. See also “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q for a detailed discussion of the potential impacts on our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders from the COVID-19 pandemic.
Overview
Refer to Note 1 of our condensed consolidated financial statements included herein (the “Condensed Consolidated Financial Statements”) for further discussion of our business and organization.
COVID-19 Pandemic
During the first quarter of 2020, there was a global outbreak of a novel coronavirus, or COVID-19, which has spread to over 200 countries and territories, including the United States, has spread to every state in the United States, and is continuing to spread. On March 11, 2020, the World Health Organization declared COVID-19 a pandemic, and since then, numerous countries, including the U.S., have declared national emergencies with respect to COVID-19 and have instituted “stay-at-home” guidelines or orders to help prevent its spread. Such actions are creating disruptions in global supply chains, increasing rates of unemployment and adversely impacting many industries. The outbreak could have a continued adverse impact on economic and market conditions and trigger a period of global economic slowdown.
The outbreak of COVID-19 and its impact on the current financial, economic and capital markets environment, and future developments in these and other areas, present uncertainty and risk with respect to our financial condition, results of operations, liquidity, and ability to pay distributions. We expect that these impacts are likely to continue to some extent as the outbreak persists and potentially even longer. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions, and, as a result, present material uncertainty and risk with respect to us and the performance of our investments. The full extent of the impact and effects of COVID-19 will depend on future developments, including, among other factors, the duration and spread of the outbreak, along with related travel advisories, quarantines and restrictions, the recovery time of the disrupted supply chains and industries, the impact of labor market interruptions, the impact of government interventions, and uncertainty with respect to the duration of the global economic slowdown.
Further discussion of the potential impacts on our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders from the COVID-19 pandemic is provided in the section entitled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Asset Performance and Collections
We maintain an in-house team of asset management professionals who oversee our commercial loans and are in regular communication with these borrowers. We have utilized these relationships to address the potential impacts of the COVID-19 pandemic to the assets which secure our loans, particularly hospitality assets. Some of our borrowers have indicated that due to the impact of the COVID-19 pandemic, they will be unable to timely execute their business plans, have had to temporarily close their businesses, or have experienced other negative business consequences which have led to cash flow pressures at the underlying properties. In some cases, these borrowers have requested temporary interest deferral or forbearance, or other modifications of their loans.
During the three months ended June 30, 2020, we closed nine payment related loan modifications, representing an aggregate principal balance of $887.0 million and $4.4 million of interest deferrals in the quarter. Subsequent to quarter end, we closed an additional two payment related loan modifications, representing an aggregate principal balance of $180.5 million. These loan modifications principally included temporary deferrals of interest and the repurposing of reserves, many of which were coupled with additional equity commitments from sponsors. We are generally encouraged by our borrowers’ initial response to the COVID-19 pandemic’s impacts on their properties. While we believe the principal amounts of our loans are generally adequately protected by underlying collateral value, there is a risk that we will not realize the entire principal value of certain investments.
Within residential lending, we continue to monitor the impact of forbearance arrangements granted by our master servicer. For loans which have been securitized, the servicer has advanced 100% of all unpaid principal and interest.
In our property segment, we collected 97% of rents due in the three months ended June 30, 2020 and granted no lease modifications. Collections were particularly strong in our Woodstar I and Woodstar II affordable housing portfolios, where 98% of rent due was collected. Given current demographic trends, which tend to favor flexible rental arrangements, we continue to see sustained demand in multifamily and decreased turnover.
66
In our infrastructure segment, we collected 100% of interest due in the three months ended June 30, 2020. Our borrowers did not request, nor did we grant, any payment related loan modifications during the three months ended June 30, 2020.
Developments During the Second Quarter of 2020
Commercial and Residential Lending Segment
67
Developments During the First Quarter of 2020
Corporate Financing
Subsequent Events
Refer to Note 23 to the Condensed Consolidated Financial Statements for disclosure regarding significant transactions that occurred subsequent to June 30, 2020.
68
Results of Operations
The discussion below is based on accounting principles generally accepted in the United States of America (“GAAP”) and therefore reflects the elimination of certain key financial statement line items related to the consolidation of securitization variable interest entities (“VIEs”), particularly within revenues and other income, as discussed in Note 2 to the Condensed Consolidated Financial Statements. For a discussion of our results of operations excluding the impact of Accounting Standards Codification (“ASC”) Topic 810 as it relates to the consolidation of securitization VIEs, refer to the section captioned “Non-GAAP Financial Measures”.
The following table compares our summarized results of operations for the three and six months ended June 30, 2020 and 2019 by business segment (amounts in thousands):
$ Change
(19,413)
17,194
(6,257)
(11,486)
(8,790)
(15,306)
(21,543)
(43,998)
(6)
(26)
Securitization VIE eliminations
10,434
10,127
(45,575)
(43,495)
(4,838)
30,754
(7,412)
(5,179)
(13,920)
(11,792)
(13,538)
(200)
18,884
112
(31,237)
17,089
24,547
(40,960)
2,211
3,472
3,455
15,769
20,836
(50,688)
(10,792)
8,883
(10,235)
(10,048)
30,022
(73,572)
Income (loss) before income taxes:
9,972
(54,520)
3,366
(2,835)
1,772
14,383
11,085
(81,148)
(10,598)
(10,027)
87
15,684
(134,156)
4,831
11,894
(7,875)
(2,250)
69
12,640
(124,512)
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
Revenues
For the three months ended June 30, 2020, revenues of our Commercial and Residential Lending Segment decreased $19.4 million to $168.4 million, compared to $187.8 million for the three months ended June 30, 2019. This decrease was primarily due to decreases in interest income from loans of $12.9 million and investment securities of $7.0 million. The decrease in interest income from loans was principally due to (i) lower prepayment related income and (ii) lower average LIBOR rates (partially mitigated by the LIBOR floors on most of our commercial loans), both partially offset by (iii) higher average balances of both commercial and residential loans. The decrease in interest income from investment securities was primarily due to lower prepayment related income and lower average LIBOR rates.
Costs and Expenses
For the three months ended June 30, 2020, costs and expenses of our Commercial and Residential Lending Segment decreased $4.8 million to $64.2 million, compared to $69.0 million for the three months ended June 30, 2019. This decrease was primarily due to a $16.7 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio, partially offset by a $9.2 million increase in credit loss provision and a $1.9 million increase in general and administrative expenses. The decrease in interest expense was primarily due to lower average LIBOR rates partially offset by higher average borrowings outstanding. The increase in the credit loss provision was due to the recognition of current expected credit losses (“CECL”) during the quarter ended June 30, 2020 in accordance with the new credit loss accounting standard effective January 1, 2020 (see Notes 2 and 4 to the Condensed Consolidated Financial Statements). The CECL provision in the 2020 second quarter increased as a result of continued poor macroeconomic conditions due to the economic disruption caused by the COVID-19 pandemic and adjusted expected repayment timing on our commercial loans.
Net Interest Income (amounts in thousands)
Change
(12,935)
(7,022)
(41,871)
(58,564)
16,693
Net interest income
125,610
128,874
(3,264)
For the three months ended June 30, 2020, net interest income of our Commercial and Residential Lending Segment decreased $3.3 million to $125.6 million, compared to $128.9 million for the three months ended June 30, 2019. This decrease reflects the decrease in interest income partially offset by the decrease in interest expense on our secured financing facilities, both as discussed in the sections above.
During the three months ended June 30, 2020 and 2019, the weighted average unlevered yields on the Commercial and Residential Lending Segment’s loans and investment securities were as follows:
7.5
6.5
6.7
Overall
7.4
The overall weighted average unlevered yield was lower due to the lower levels of prepayment related income and decreases in LIBOR.
During the three months ended June 30, 2020 and 2019, the Commercial and Residential Lending Segment’s weighted average secured borrowing rates, inclusive of interest rate hedging costs and the amortization of deferred financing fees, were 2.7% and 4.5%, respectively. The decrease in borrowing rates primarily reflects decreases in LIBOR.
Other Income
For the three months ended June 30, 2020, other income of our Commercial and Residential Lending Segment increased $24.5 million to $33.3 million compared to $8.8 million for the three months ended June 30, 2019. This increase was primarily due to (i) a $27.6 million favorable change in fair value of residential mortgage loans, (ii) a $13.9 million favorable change in foreign currency gain (loss) and (iii) a $6.4 million favorable change in fair value of investment securities, all partially offset by (iv) a $17.3 million unfavorable change in gain (loss) on derivatives and (v) a $4.8 million decrease in earnings from unconsolidated entities. Favorable changes in fair value of residential mortgage loans and investment securities reflect partial recoveries of unfavorable changes in the first quarter of 2020 that were attributable to widening credit spreads resulting from market disruption and dislocation caused by the impacts of COVID-19. Those credit spreads began to tighten in the second quarter of 2020. The unfavorable change in gain (loss) on derivatives reflects a $20.5 million unfavorable change in foreign currency hedges, partially offset by a $3.2 million favorable change in interest rate swaps. The foreign currency hedges are used to fix the U.S. dollar amounts of cash flows (both interest and principal payments) we expect to receive from our foreign currency denominated loans and investments. The unfavorable change in the foreign currency hedges and the favorable change in foreign currency gain (loss) reflect the overall weakening of the U.S. dollar against the Australian Dollar (“AUD”) and EUR in the second quarter of 2020 compared to a strengthening of the U.S. dollar against the GBP in the second quarter of 2019. The interest rate swaps are used primarily to fix our interest rate payments on certain variable rate borrowings which fund fixed rate investments.
For the three months ended June 30, 2020, revenues of our Infrastructure Lending Segment decreased $6.3 million to $19.9 million, compared to $26.2 million for the three months ended June 30, 2019. This decrease was primarily due to decreases in interest income from loans of $6.2 million and investment securities of $0.2 million. The decrease in interest income from loans was primarily due to lower average LIBOR rates.
For the three months ended June 30, 2020, costs and expenses of our Infrastructure Lending Segment decreased $7.4 million to $14.1 million, compared to $21.5 million for the three months ended June 30, 2019. The decrease was primarily due to a $6.6 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio and a $1.5 million decrease in credit loss provision. The decrease in interest expense was primarily due to lower average LIBOR rates. The decrease in the credit loss provision was primarily due to the reversal of a portion of the CECL allowance during the quarter ended June 30, 2020 reflecting adjusted expected repayment timing on our infrastructure loans as well as some loan paydowns.
(6,165)
(185)
(9,678)
(16,258)
6,580
10,131
9,901
230
71
For the three months ended June 30, 2020, net interest income of our Infrastructure Lending Segment increased $0.2 million to $10.1 million, compared to $9.9 million for the three months ended June 30, 2019. The increase reflects the decrease in interest expense on the secured financing facilities, partially offset by the decrease in interest income, both as discussed in the sections above.
During the three months ended June 30, 2020 and 2019, the weighted average unlevered yields on the Infrastructure Lending Segment’s investments were as follows:
Loans and investment securities held-for-investment
5.1
6.3
3.2
During the three months ended June 30, 2020 and 2019, the Infrastructure Lending Segment’s weighted average secured borrowing rate, inclusive of the amortization of deferred financing fees, was 3.3% and 4.8%, respectively.
Other Loss
For the three months ended June 30, 2020 and 2019, other loss of our Infrastructure Lending Segment decreased $2.2 million to $1.2 million, compared to $3.4 million for the three months ended June 30, 2019. The decrease in other loss primarily reflects the non-recurrence of a $2.8 million loss on extinguishment of debt in the second quarter of 2019 resulting from the write-off of deferred financing fees relating to partial debt prepayments from proceeds of loan repayments and sales.
Change in Results by Portfolio (amounts in thousands)
$ Change from prior period
Costs and
Gain (loss) on derivative
Income (loss) before
expenses
financial instruments
Other income (loss)
income taxes
(1,312)
(1,792)
5,834
6,314
751
2,413
(57)
(1,702)
(3,421)
628
(39)
Ireland Portfolio
(8,874)
(7,510)
756
(599)
(1,044)
Other/Corporate
(253)
(341)
(74)
6,533
(3,078)
See Note 6 to the Condensed Consolidated Financial Statements for a description of the above-referenced Property Segment portfolios. The Ireland Portfolio, which was comprised of 11 office properties and one multifamily property all located in Dublin, Ireland, was sold in December 2019.
For the three months ended June 30, 2020, revenues of our Property Segment decreased $8.8 million to $63.6 million, compared to $72.4 million for the three months ended June 30, 2019. The decrease in revenues was primarily due to the sale of the Ireland Portfolio in December 2019.
For the three months ended June 30, 2020, costs and expenses of our Property Segment decreased $7.1 million to $61.1 million, compared to $68.2 million for the three months ended June 30, 2019. The decrease in costs and expenses primarily reflects the sale of the Ireland Portfolio in December 2019.
72
For the three months ended June 30, 2020, other loss of our Property Segment decreased $3.4 million to $6.7 million, compared to $10.1 million for the three months ended June 30, 2019. The decrease in other loss was primarily due to (i) a $6.5 million decreased loss on derivatives, $5.8 million of which was attributable to interest rate swaps which primarily hedge the variable interest rate risk on borrowings secured by our Medical Office Portfolio, partially offset by (ii) a $2.2 million loss on extinguishment of debt in the second quarter of 2020 in connection with the refinancing of our Woodstar I Portfolio and (iii) $1.0 million of earnings in the second quarter of 2019 that did not recur in the 2020 second quarter from our equity investee that owns four regional shopping malls (the “Retail Fund”), which is an investment company that measures its assets at fair value. Our investment in the Retail Fund was written off as of December 31, 2019 due to continued declines in the estimated fair values of its properties.
For the three months ended June 30, 2020, revenues of our Investing and Servicing Segment decreased $21.5 million to $44.1 million, compared to $65.6 million for the three months ended June 30, 2019. The decrease in revenues in the second quarter of 2020 was primarily due to decreases of $7.5 million in interest income from conduit loans and CMBS, $7.3 million in servicing fees and $6.5 million in rental income from our REIS Equity Portfolio (see Note 6 to the Condensed Consolidated Financial Statements) due to fewer properties held and an owned hotel which was closed during the quarter due to COVID-19. The decrease in interest income primarily reflects a $6.8 million decrease in interest recoveries on CMBS.
For the three months ended June 30, 2020, costs and expenses of our Investing and Servicing Segment decreased $11.8 million to $29.0 million, compared to $40.8 million for the three months ended June 30, 2019. The decrease in costs and expenses was primarily due to decreases of $5.2 million in general and administrative expenses reflecting lower incentive compensation, $4.3 million in costs of rental operations, depreciation and amortization due to fewer properties held and $2.3 million in interest expense on borrowings related to properties held and conduit loans.
For the three months ended June 30, 2020, other income of our Investing and Servicing Segment increased $20.8 million to $47.8 million, compared to $27.0 million for the three months ended June 30, 2019. The increase in other income was primarily due to (i) realized and unrealized gains totaling $27.9 million resulting from the sale in April 2020 of a portion of our unconsolidated equity interest in a servicing and advisory business, as further described in Note 7 to the Condensed Consolidated Financial Statements, (ii) a $7.4 million gain on sale of an operating property in the second quarter of 2020, (iii) a $6.5 million favorable change in fair value of servicing rights and (iv) a $3.1 million decreased loss on derivatives which primarily hedge our interest rate risk on conduit loans, all partially offset by (v) a $15.1 million lesser increase in fair value of conduit loans and (vi) a $7.9 million lesser increase in fair value of CMBS investments.
Corporate and Other Items
Corporate Costs and Expenses
For the three months ended June 30, 2020, corporate expenses decreased $0.2 million to $53.7 million, compared to $53.9 million for the three months ended June 30, 2019.
Corporate Other Income
For the three months ended June 30, 2020, corporate other income decreased $10.8 million to $4.5 million, compared to $15.3 million for the three months ended June 30, 2019. The decrease in corporate other income was
73
primarily due to decreased gains on interest rate swaps which hedge a portion of our unsecured senior notes used to repay variable-rate secured financing.
Securitization VIE Eliminations
Securitization VIE eliminations primarily reclassify interest income and servicing fee revenues to other income (loss) for the CMBS and RMBS VIEs that we consolidate as primary beneficiary. Such eliminations have no overall effect on net income (loss) attributable to Starwood Property Trust. The reclassified revenues, along with applicable changes in fair value of investment securities and servicing rights, comprise the other income (loss) caption “Change in net assets related to consolidated VIEs,” which represents our beneficial interest in those consolidated VIEs. The magnitude of the securitization VIE eliminations is merely a function of the number of CMBS and RMBS trusts consolidated in any given period, and as such, is not a meaningful indicator of operating results. The eliminations primarily relate to CMBS trusts for which the Investing and Servicing Segment is deemed the primary beneficiary and, to a much lesser extent, some CMBS and RMBS trusts for which the Commercial and Residential Lending Segment is deemed the primary beneficiary.
Income Tax Benefit (Provision)
Our consolidated income taxes principally relate to the taxable nature of our loan servicing and loan conduit businesses and certain other real estate related investing activities which are housed in taxable REIT subsidiaries (“TRSs”). For the three months ended June 30, 2020, our income taxes decreased from a provision of $3.5 million to a benefit of $1.3 million due to tax losses of our TRSs in the second quarter of 2020.
Net Income Attributable to Non-controlling Interests
During the three months ended June 30, 2020, net income attributable to non-controlling interests increased $7.9 million to $13.3 million, compared to $5.4 million during the three months ended June 30, 2019. The increase was primarily due to non-controlling interests in earnings of a consolidated CMBS joint venture in which we hold a 51% interest.
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
For the six months ended June 30, 2020, revenues of our Commercial and Residential Lending Segment increased $17.2 million to $379.8 million, compared to $362.6 million for the six months ended June 30, 2019. This increase was primarily due to an increase in interest income from loans of $24.9 million, partially offset by a decrease in interest income from investment securities of $8.3 million. The increase in interest income from loans was principally due to (i) higher prepayment related income and (ii) higher average balances of both commercial and residential loans, partially offset by (iii) lower average LIBOR rates (partially mitigated by the LIBOR floors on most of our commercial loans). The decrease in interest income from investment securities was primarily due to lower prepayment related income and lower average LIBOR rates.
For the six months ended June 30, 2020, costs and expenses of our Commercial and Residential Lending Segment increased $30.8 million to $169.0 million, compared to $138.2 million for the six months ended June 30, 2019. This increase was primarily due to a $49.4 million increase in credit loss provision and a $3.2 million increase in general and administrative expenses, partially offset by a $24.3 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio. The increase in the credit loss provision was due to the recognition of current expected credit losses (“CECL”) during the six months ended June 30, 2020 in accordance with the new credit loss accounting standard effective January 1, 2020 (see Notes 2 and 4 to the Condensed Consolidated Financial Statements). The CECL provision in the first half of 2020 was magnified by the
significant deterioration in macroeconomic forecasts between the January 1 CECL effective date and the June 30 period end due to the economic disruption caused by the COVID-19 pandemic. The decrease in interest expense was primarily due to lower average LIBOR rates partially offset by higher average borrowings outstanding.
24,851
(8,302)
(95,821)
(120,168)
24,347
282,669
241,773
40,896
For the six months ended June 30, 2020, net interest income of our Commercial and Residential Lending Segment increased $40.9 million to $282.7 million, compared to $241.8 million for the six months ended June 30, 2019. This increase reflects the net increase in interest income and the decrease in interest expense, both as discussed in the sections above.
During the six months ended June 30, 2020 and 2019, the weighted average unlevered yields on the Commercial and Residential Lending Segment’s loans and investment securities were as follows:
6.6
7.6
6.8
The overall weighted average unlevered yield was lower as higher levels of prepayment related income were more than offset by decreases in LIBOR.
During the six months ended June 30, 2020 and 2019, the Commercial and Residential Lending Segment’s weighted average secured borrowing rates, inclusive of interest rate hedging costs and the amortization of deferred financing fees, were 3.1% and 4.6%, respectively. The decrease in borrowing rates primarily reflects decreases in LIBOR.
Other Income (Loss)
For the six months ended June 30, 2020, other income (loss) of our Commercial and Residential Lending Segment decreased $41.0 million to a loss of $33.2 million compared to income of $7.8 million for the six months ended June 30, 2019. This decrease was primarily due to (i) a $25.4 million increase in foreign currency loss, (ii) a $19.8 million unfavorable change in fair value of investment securities, (iii) a $9.3 million unfavorable change in fair value of residential mortgage loans, (iv) a $5.3 million decrease in earnings from unconsolidated entities and (v) a $4.0 million unfavorable change in gains (losses) on sales of loans and securities, all partially offset by (vi) a $22.8 million favorable change in gain (loss) on derivatives. Changes in fair value are attributable to widening credit spreads resulting from market disruption and dislocation caused by the impacts of COVID-19. The favorable change in gain (loss) on derivatives reflects a $41.2 million increased gain on foreign currency hedges, partially offset by an $18.4 million unfavorable change in interest rate swaps. The foreign currency hedges are used to fix the U.S. dollar amounts of cash flows (both interest and principal payments) we expect to receive from our foreign currency denominated loans and investments. The increased gain on foreign currency hedges and the increased foreign currency loss reflect the overall strengthening of the U.S. dollar against the GBP and EUR in the first half of 2020 versus a lesser strengthening of the U.S. dollar against those currencies in the first half of 2019. The interest rate swaps are used primarily to fix our interest rate payments on certain variable rate borrowings which fund fixed rate investments.
75
For the six months ended June 30, 2020, revenues of our Infrastructure Lending Segment decreased $11.5 million to $43.2 million, compared to $54.7 million for the six months ended June 30, 2019. This decrease was primarily due to decreases in interest income from loans of $10.7 million and investment securities of $0.4 million. The decrease in interest income from loans was primarily due to lower average loan balances outstanding as a result of sales and repayments and a decrease in average LIBOR rates partially offset by an increase in average spreads on our infrastructure loans.
For the six months ended June 30, 2020, costs and expenses of our Infrastructure Lending Segment decreased $5.2 million to $40.2 million, compared to $45.4 million for the six months ended June 30, 2019. The decrease was primarily due to a $12.0 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio, partially offset by a $6.2 million increase in credit loss provision. The decrease in interest expense was primarily due to lower average LIBOR rates and lower average borrowings as a result of loan sales and repayments. The increase in the credit loss provision was due to the recognition of CECL during the six months ended June 30, 2020 in accordance with the new credit loss accounting standard effective January 1, 2020. As discussed above, the CECL provision was magnified by the significant deterioration in macroeconomic forecasts due to the economic disruption caused by the COVID-19 pandemic.
(10,667)
(369)
(22,795)
(34,835)
12,040
20,128
19,124
1,004
For the six months ended June 30, 2020, net interest income of our Infrastructure Lending Segment increased $1.0 million to $20.1 million, compared to $19.1 million for the six months ended June 30, 2019. The increase reflects the decrease in interest expense on the secured financing facilities, which was partially offset by the decrease in interest income, both as discussed in the sections above.
During the six months ended June 30, 2020 and 2019, the weighted average unlevered yields on the Infrastructure Lending Segment’s investments were as follows:
3.6
4.0
During the six months ended June 30, 2020 and 2019, the Infrastructure Lending Segment’s weighted average secured borrowing rate, inclusive of the amortization of deferred financing fees, was 3.8% and 4.9%, respectively.
For the six months ended June 30, 2020, other loss of our Infrastructure Lending Segment decreased $3.5 million to $2.6 million, compared to $6.1 million for the six months ended June 30, 2019. The decrease in other loss primarily reflects a decreased loss on extinguishment of debt resulting from the write-off of deferred financing fees relating to partial debt prepayments from proceeds of loan repayments and sales.
$ Change from prior year
(1,283)
(4,122)
(18,470)
(15,631)
2,071
4,593
(4,281)
1,747
537
1,210
(17,858)
(15,011)
(6,453)
(9,300)
42,761
(310)
(24,980)
40,749
For the six months ended June 30, 2020, revenues of our Property Segment decreased $15.3 million to $127.7 million, compared to $143.0 million for the six months ended June 30, 2019. The decrease in revenues was primarily due to the sale of the Ireland Portfolio in December 2019, partially offset by increased rental income in the Woodstar Portfolios due to rental rate increases effective May 2019.
For the six months ended June 30, 2020, costs and expenses of our Property Segment decreased $13.9 million to $121.8 million, compared to $135.7 million for the six months ended June 30, 2019. The decrease in costs and expenses primarily reflects the sale of the Ireland Portfolio in December 2019.
For the six months ended June 30, 2020, other loss of our Property Segment decreased $15.8 million to $36.8 million, compared to $52.6 million for the six months ended June 30, 2019. The decrease in other loss was primarily due to a $42.8 million loss in the 2019 period that did not recur in the 2020 period from our investment in the Retail Fund. Our investment in the Retail Fund was written off as of December 31, 2019 due to continued declines in the estimated fair values of its properties. Partially offsetting the effect of the Retail Fund was a $25.0 million increased loss on derivatives, consisting of (i) an $18.5 million increased loss on interest rate swaps which primarily hedge the variable interest rate risk on borrowings secured by our Medical Office Portfolio and (ii) the non-recurrence of a $6.5 million gain in the 2019 first quarter on foreign exchange contracts which hedged our Euro currency exposure with respect to the Ireland Portfolio.
77
For the six months ended June 30, 2020, revenues of our Investing and Servicing Segment decreased $44.0 million to $88.6 million, compared to $132.6 million for the six months ended June 30, 2019. The decrease in revenues was primarily due to decreases of $28.1 million in servicing fees, $9.7 million in rental income from our REIS Equity Portfolio due to fewer properties held and an owned hotel which was closed during the quarter due to COVID-19 and $6.3 million in interest income from conduit loans and CMBS, which reflects a $5.9 million decrease in interest recoveries on CMBS.
For the six months ended June 30, 2020, costs and expenses of our Investing and Servicing Segment decreased $13.6 million to $65.9 million, compared to $79.5 million for the six months ended June 30, 2019. The decrease in costs and expenses was primarily due to decreases of $7.5 million in costs of rental operations, depreciation and amortization due to fewer properties held, $3.4 million in general and administrative expenses reflecting lower incentive compensation and $2.9 million in interest expense on borrowings related to properties held and conduit loans.
For the six months ended June 30, 2020, other income of our Investing and Servicing Segment decreased $50.7 million to $1.9 million, compared to $52.6 million for the six months ended June 30, 2019. The decrease in other income was primarily due to (i) a $73.2 million unfavorable change in fair value of CMBS investments primarily due to widening credit spreads resulting from market disruption and dislocation caused by the impacts of COVID-19, (ii) a $12.5 million increased loss on derivatives which primarily hedge our interest rate risk on conduit loans and (iii) a $5.6 million lesser increase in fair value of conduit loans, all partially offset by (iv) realized and unrealized gains totaling $27.9 million resulting from the sale in April 2020 of a portion of our unconsolidated equity interest in a servicing and advisory business, as further described in Note 7 to the Condensed Consolidated Financial Statements, (v) a $7.3 million favorable change in fair value of servicing rights and (vi) a $6.5 million increased gain on sale of operating properties.
For the six months ended June 30, 2020, corporate expenses increased $18.9 million to $127.0 million, compared to $108.1 million for the six months ended June 30, 2019. The increase was primarily due to a $17.6 million increase in management fees.
For the six months ended June 30, 2020, corporate other income increased $8.9 million to $33.7 million, compared to $24.8 million for the six months ended June 30, 2019. The increase in corporate other income was primarily due to increased gains on interest rate swaps which hedge a portion of our unsecured senior notes used to repay variable-rate secured financing.
Refer to the preceding comparison of the three months ended June 30, 2020 to the three months ended June 30, 2019 for a discussion of the nature of securitization VIE eliminations.
Our consolidated income taxes principally relate to the taxable nature of our loan servicing and loan conduit businesses and certain other real estate related investing activities which are housed in taxable REIT subsidiaries
78
(“TRSs”). For the six months ended June 30, 2020, our income taxes decreased from a provision of $3.9 million to a benefit of $8.0 million due to tax losses of our TRSs in the first half of 2020.
During the six months ended June 30, 2020, net income attributable to non-controlling interests increased $2.2 million to $13.8 million, compared to $11.6 million during the six months ended June 30, 2019. The increase was primarily due to non-controlling interests in earnings of a consolidated CMBS joint venture in which we hold a 51% interest.
Non-GAAP Financial Measures
Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding the following:
We believe that Core Earnings provides an additional measure of our core operating performance by eliminating the impact of certain non-cash expenses and facilitating a comparison of our financial results to those of other comparable REITs with fewer or no non-cash adjustments and comparison of our own operating results from period to period. Our management uses Core Earnings in this way, and also uses Core Earnings to compute the incentive fee due under our management agreement. The Company believes that its investors also use Core Earnings or a comparable supplemental performance measure to evaluate and compare the performance of the Company and its peers, and as such, the Company believes that the disclosure of Core Earnings is useful to (and expected by) its investors.
However, the Company cautions that Core Earnings does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (loss) (determined in accordance with GAAP), or an indication of our cash flows from operating activities (determined in accordance with GAAP), a measure of our liquidity, or an indication of funds available to fund our cash needs, including our ability to make cash distributions. In addition, our methodology for calculating Core Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and accordingly, our reported Core Earnings may not be comparable to the Core Earnings reported by other REITs.
The weighted average diluted share count applied to Core Earnings for purposes of determining Core Earnings per share (“EPS”) is computed using the GAAP diluted share count, adjusted for the following:
79
The following table presents our diluted weighted average shares used in our GAAP EPS calculation reconciled to our diluted weighted average shares used in our Core EPS calculation (amounts in thousands):
Diluted weighted average shares - GAAP
Add: Unvested stock awards
2,794
2,092
2,635
2,172
Add: Woodstar II Class A Units
10,648
11,571
10,693
11,740
Less: Convertible Notes dilution
(9,649)
(9,963)
Diluted weighted average shares - Core
295,086
293,086
294,768
292,478
The definition of Core Earnings allows management to make adjustments, subject to the approval of a majority of our independent directors, in situations where such adjustments are considered appropriate in order for Core Earnings to be calculated in a manner consistent with its definition and objective. No adjustments to the definition of Core Earnings became effective during the six months ended June 30, 2020.
As a reminder, in 2015, we adjusted the calculation of Core Earnings related to the equity component of our Convertible Notes. We previously amortized the equity component of these instruments through interest expense for Core Earnings purposes, consistent with our GAAP treatment. However, for Core Earnings purposes, the amount is not considered realized until the earlier of (a) the entire issuance of the notes has been extinguished; or (b) the equity portion has been fully amortized via repurchases of the notes.
In January 2019, our 2019 Convertible Notes were fully repaid in shares of common stock and cash. The equity portion of the 2019 Convertible Notes had been fully amortized.
The following table summarizes our quarterly Core Earnings per weighted average diluted share for the six months ended June 30, 2020 and 2019:
Core Earnings For the Three-Month Periods Ended
March 31
June 30
0.55
0.43
0.28
0.52
Core Earnings per weighted average diluted share for the six months ended June 30, 2019 does not equal the sum of the individual quarters due to rounding and other computational factors.
80
The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended June 30, 2020, by business segment (amounts in thousands, except per share data):
and
Costs and expenses
(64,191)
(14,112)
(61,105)
(28,992)
(53,747)
(222,147)
Income attributable to non-controlling interests
Add / (Deduct):
Non-controlling interests attributable to Woodstar II Class A Units
5,111
Non-cash equity compensation expense
1,436
481
1,247
4,130
7,352
(72)
370
19,236
3,337
23,022
Interest income adjustment for securities
1,149
1,627
2,776
Extinguishment of debt, net
(247)
Income tax provision (benefit) associated with fair value adjustments
1,914
1,522
Other non-cash items
(485)
156
(95)
Reversal of GAAP unrealized (gains) / losses on:
(33,010)
(1,440)
(34,450)
(5,454)
(7,941)
(13,395)
11,043
420
3,401
3,524
(240)
18,148
Foreign currency
(6,942)
(7,173)
(671)
1,118
(29,526)
(29,079)
Recognition of Core realized gains / (losses) on:
(5,663)
(5,664)
(181)
4,522
(10)
4,143
(1,969)
(1,998)
(Loss) earnings from unconsolidated entities
(733)
12,992
12,235
Sales of properties
(5,789)
Core Earnings (Loss)
112,478
4,511
17,614
36,970
(45,431)
126,142
Core Earnings (Loss) per Weighted Average Diluted Share
0.38
0.02
0.06
0.12
(0.15)
81
The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended June 30, 2019, by business segment (amounts in thousands, except per share data):
(69,029)
(21,524)
(68,212)
(40,784)
(53,947)
(253,496)
5,355
911
563
1,702
3,811
7,064
(305)
(356)
(773)
23,416
4,822
28,523
(194)
3,381
3,187
(246)
(452)
371
150
(5,363)
(16,528)
(21,891)
948
(15,815)
(14,867)
(5,519)
2,833
12,717
6,927
(15,858)
7,017
(5,492)
(2,754)
(9,290)
(550)
(755)
20,155
18,850
597
(423)
736
(2,228)
1,484
(7,614)
(7,622)
(1,205)
(1,148)
4,682
4,137
8,819
124,544
2,354
30,201
47,887
(51,131)
153,855
0.42
0.01
0.10
0.16
(0.17)
82
The Commercial and Residential Lending Segment’s Core Earnings decreased by $12.0 million, from $124.5 million during the second quarter of 2019 to $112.5 million in the second quarter of 2020. After making adjustments for the calculation of Core Earnings, revenues were $169.5 million, costs and expenses were $50.9 million and other loss was $4.8 million.
Core revenues, consisting principally of interest income on loans, decreased by $18.1 million in the second quarter of 2020, primarily due to decreases in interest income from loans of $12.9 million and investment securities of $5.7 million. The decrease in interest income from loans was principally due to (i) lower prepayment related income and (ii) lower average LIBOR rates (partially mitigated by the LIBOR floors on most of our commercial loans), both partially offset by (iii) higher average balances of both commercial and residential loans. The decrease in interest income from investment securities was primarily due to lower prepayment related income and lower average LIBOR rates.
Core costs and expenses decreased by $14.9 million in the second quarter of 2020, primarily due to a $16.7 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio primarily due to lower average LIBOR rates partially offset by higher average borrowings outstanding. Such decrease was partially offset by higher general and administrative and other expenses.
Core other income (loss) decreased by $9.4 million in the second quarter of 2020, primarily due to a $5.1 million core loss on a residential loan securitization in the second quarter of 2020 and a $4.7 million decrease in earnings from unconsolidated entities.
The Infrastructure Lending Segment’s Core Earnings increased by $2.1 million, from $2.4 million in the second quarter of 2019 to $4.5 million in the second quarter of 2020. After making adjustments for the calculation of Core Earnings, revenues were $19.9 million, costs and expenses were $14.6 million and other loss was $0.7 million.
Core revenues, consisting principally of interest income on loans, decreased by $6.3 million in the second quarter of 2020, primarily due to decreases in interest income from loans of $6.2 million and investment securities of $0.2 million. The decrease in interest income from loans was primarily due to lower average LIBOR rates.
Core costs and expenses decreased by $5.9 million in the second quarter of 2020, primarily due to a decrease in interest expense on the secured debt facilities used to finance this segment’s investment portfolio principally due to lower average LIBOR rates.
Core other loss decreased by $2.8 million in the second quarter of 2020, primarily due to the non-recurrence of a $2.8 million loss on extinguishment of debt in the second quarter of 2019 resulting from the write-off of deferred financing fees relating to partial debt prepayments from proceeds of loan repayments and sales.
Core Earnings by Portfolio (amounts in thousands)
4,230
4,300
(70)
3,782
6,643
(2,861)
4,320
7,746
(3,426)
6,373
5,550
823
6,962
(1,091)
(1,000)
(91)
Core Earnings
(12,587)
The Property Segment’s Core Earnings decreased by $12.6 million, from $30.2 million during the second quarter of 2019 to $17.6 million in the second quarter of 2020. After making adjustments for the calculation of Core Earnings, revenues were $63.2 million, costs and expenses were $42.3 million and other loss was $3.3 million.
Core revenues decreased by $9.1 million in the second quarter of 2020, primarily due to the sale of the Ireland Portfolio in December 2019.
Core costs and expenses decreased by $2.8 million in the second quarter of 2020, primarily due to the sale of the Ireland Portfolio in December 2019.
Core other income (loss) decreased by $6.3 million in the second quarter of 2020 primarily due to (i) a $4.3 million unfavorable change in realized gains (losses) on certain interest rate and foreign currency derivatives and (ii) a $2.2 million loss on extinguishment of debt in the second quarter of 2020 in connection with the refinancing of our Woodstar I Portfolio.
The Investing and Servicing Segment’s Core Earnings decreased by $10.9 million, from $47.9 million during the second quarter of 2019 to $37.0 million in the second quarter of 2020. After making adjustments for the calculation of Core Earnings, revenues were $46.0 million, costs and expenses were $24.6 million, other income was $15.0 million, income tax benefit was $4.2 million and the deduction of income attributable to non-controlling interests was $3.6 million.
Core revenues decreased by $23.3 million in the second quarter of 2020, primarily due to decreases of $9.3 million in interest income from conduit loans and CMBS, $7.3 million in servicing fees and $6.5 million in rental income from our REIS Equity Portfolio due to fewer properties held and an owned hotel which was closed during the quarter due to COVID-19. The treatment of CMBS interest income on a GAAP basis is complicated by our application of the ASC 810 consolidation rules. In an attempt to treat these securities similar to the trust’s other investment securities, we compute core interest income pursuant to an effective yield methodology. In doing so, we segregate the portfolio into various categories based on the components of the bonds’ cash flows and the volatility related to each of these components. We then accrete interest income on an effective yield basis using the components of cash flows that are reliably estimable. Other minor adjustments are made to reflect management’s expectations for other components of the projected cash flow stream. The decrease in interest income primarily reflects a $6.8 million decrease in interest recoveries on CMBS.
Core costs and expenses decreased by $9.9 million in the second quarter of 2020, primarily due to decreases of $4.7 million in general and administrative expenses reflecting lower incentive compensation, $2.8 million in costs of rental operations due to fewer properties held and $2.3 million in interest expense on borrowings related to properties held and conduit loans.
.
Core other income includes profit realized upon securitization of loans by our conduit business, gains on sales of CMBS and operating properties, gains and losses on derivatives that were either effectively terminated or novated, and earnings from unconsolidated entities. These items are typically offset by a decrease in the fair value of our domestic servicing rights intangible which reflects the expected amortization of this deteriorating asset, net of increases in fair value due to the attainment of new servicing contracts. Derivatives include instruments which hedge interest rate risk and credit risk on our conduit loans. For GAAP purposes, the loans, CMBS and derivatives are accounted for at fair value, with all changes in fair value (realized or unrealized) recognized in earnings. The adjustments to Core Earnings outlined above are also applied to the GAAP earnings of our unconsolidated entities. Core other income decreased by $0.1 million in the second quarter of 2020.
Income taxes, which principally relate to the taxable nature of our loan servicing and loan conduit businesses and certain other real estate related investing activities which are housed in TRSs, decreased $6.1 million from a provision of $1.9 million to a benefit of $4.2 million due to tax losses of our TRSs in the second quarter of 2020.
Income attributable to non-controlling interests increased $3.5 million primarily relating to income of a consolidated CMBS joint venture in which we hold a 51% interest.
Core corporate costs and expenses decreased by $5.7 million, from $51.1 million during the second quarter of 2019 to $45.4 million in the second quarter of 2020 primarily due to a favorable change in realized gain (loss) on interest rate swaps which hedge a portion of our unsecured senior notes used to repay variable-rate secured financing.
The following table presents our summarized results of operations and reconciliation to Core Earnings for the six months ended June 30, 2020, by business segment (amounts in thousands, except per share data):
(168,971)
(40,191)
(121,767)
(65,920)
(126,960)
(523,809)
Other (loss) income
10,222
2,548
947
131
2,510
10,016
16,152
Management incentive fee
15,799
564
315
725
130
38,617
7,144
46,616
1,273
7,942
9,215
(493)
Income tax benefit associated with fair value adjustment
(3,907)
(1,834)
(5,741)
(976)
478
312
(179)
2,507
(20,823)
22,425
39,275
61,700
(19,520)
1,433
33,970
22,537
(27,889)
27,059
163
(722)
(30,146)
(29,750)
(3,499)
(62)
16,558
12,997
(4,393)
7,772
118
(404)
(6,097)
1,389
(6,240)
(142)
(69)
(6,475)
(580)
16,730
15,417
260,731
10,803
40,251
71,966
(95,463)
288,288
0.88
0.04
0.14
0.24
(0.32)
0.98
The following table presents our summarized results of operations and reconciliation to Core Earnings for the six months ended June 30, 2019, by business segment (amounts in thousands, except per share data):
(138,217)
(45,370)
(135,687)
(79,458)
(108,076)
(506,808)
(Income) loss attributable to non-controlling interests
11,072
1,617
146
3,052
7,498
13,427
173
(898)
47,627
9,737
57,720
(391)
9,353
8,962
(1,457)
(886)
508
(60)
(6,749)
(26,408)
2,642
(33,955)
(31,313)
3,986
3,228
13,033
10,251
(26,002)
1,688
(217)
(6,069)
(3,348)
33,344
(1,203)
27,585
25,627
7,109
7,706
(1,460)
1,851
(9,239)
(8,025)
(814)
(827)
(1,631)
4,780
(68,905)
12,870
(51,255)
(76)
233,480
5,769
(10,099)
110,662
(103,007)
236,805
0.80
(0.04)
(0.35)
0.81
The Commercial and Residential Lending Segment’s Core Earnings increased by $27.2 million, from $233.5 million during the six months of 2019 to $260.7 million in the six months of 2020. After making adjustments for the calculation of Core Earnings, revenues were $381.1 million, costs and expenses were $113.6 million and other loss was $4.0 million.
Core revenues, consisting principally of interest income on loans, increased by $18.9 million in the six months of 2020, primarily due to an increase in interest income from loans of $24.9 million, partially offset by a decrease in interest income from investment securities of $6.6 million. The increase in interest income from loans was principally due to (i) higher prepayment related income and (ii) higher average balances of both commercial and residential loans, partially offset by (iii) lower average LIBOR rates (partially mitigated by the LIBOR floors on most of our commercial loans). The decrease in interest income from investment securities was primarily due to lower prepayment related income and lower average LIBOR rates.
Core costs and expenses decreased by $20.6 million in the six months of 2020, primarily due to a $24.3 million decrease in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio primarily due to lower average LIBOR rates partially offset by higher average borrowings outstanding. Such decrease was partially offset by higher general and administrative and other expenses.
Core other income (loss) decreased by $11.4 million in the six months of 2020, primarily due to declines of $6.8 million in gains (losses) on sales and securitizations of commercial and residential loans and $5.4 million in earnings from unconsolidated entities.
The Infrastructure Lending Segment’s Core Earnings increased by $5.0 million, from $5.8 million in the six months of 2019 to $10.8 million in the six months of 2020. After making adjustments for the calculation of Core Earnings, revenues were $43.2 million, costs and expenses were $31.7 million and other loss was $0.7 million.
Core revenues, consisting principally of interest income on loans, decreased by $11.5 million in the six months of 2020, primarily due to decreases in interest income from loans of $10.7 million and investment securities of $0.4 million. The decrease in interest income from loans was primarily due to lower average loan balances outstanding as a result of sales and repayments and a decrease in average LIBOR rates partially offset by an increase in average spreads on our infrastructure loans.
Core costs and expenses decreased by $11.3 million in the six months of 2020, primarily due to a decrease in interest expense on the secured debt facilities used to finance this segment’s investment portfolio principally due to lower average LIBOR rates and lower average borrowings as a result of loan sales and repayments.
Core other loss decreased by $5.4 million in the six months of 2020, primarily due to a decreased loss on extinguishment of debt resulting from the write-off of deferred financing fees relating to partial debt prepayments from proceeds of loan repayments and sales.
8,352
10,547
13,335
(2,788)
11,105
15,156
(4,051)
12,382
10,963
1,419
13,003
(13,003)
68,905
(2,321)
(2,003)
(318)
50,350
The Property Segment’s Core Earnings increased by $50.3 million, from a loss of $10.1 million during the six months of 2019 to income of $40.2 million in the six months of 2020. After making adjustments for the calculation of Core Earnings, revenues were $126.8 million, costs and expenses were $83.7 million and other loss was $2.9 million.
Core revenues decreased by $15.8 million in the six months of 2020, primarily due to the sale of the Ireland Portfolio in December 2019, partially offset by increased rental income in the Woodstar Portfolios due to rental rate increases effective May 2019.
Core costs and expenses decreased by $4.9 million in the six months of 2020, primarily due to the sale of the Ireland Portfolio in December 2019.
Core other loss decreased by $60.9 million in the six months of 2020 primarily due to a $68.9 million other-than-temporary loss recognized on our investment in the Retail Fund in the 2019 period that did not recur in the 2020 period, partially offset by a $6.0 million unfavorable change in realized gains (losses) on certain interest rate and foreign currency derivatives and a $2.2 million loss on extinguishment of debt in the second quarter of 2020 in connection with the refinancing of our Woodstar I Portfolio.
The Investing and Servicing Segment’s Core Earnings decreased by $38.7 million, from $110.7 million during the six months of 2019 to $72.0 million in the six months of 2020. After making adjustments for the calculation of Core Earnings, revenues were $97.2 million, costs and expenses were $56.5 million, other income was $37.2 million, income tax benefit was $4.9 million and the deduction of income attributable to non-controlling interests was $10.8 million.
Core revenues decreased by $45.3 million in the six months of 2020, primarily due to decreases of $28.1 million in servicing fees, $7.7 million in interest income from conduit loans and CMBS and $9.6 million in rental income from our REIS Equity Portfolio due to fewer properties held and an owned hotel which was closed during the quarter due to COVID-19. The decrease in interest income primarily reflects a $5.9 million decrease in interest recoveries on CMBS.
Core costs and expenses decreased by $10.5 million in the six months of 2020, primarily due to decreases of, $5.0 million in costs of rental operations due to fewer properties held, $2.9 million in interest expense on borrowings related to properties held and conduit loans and $2.8 million in general and administrative expenses reflecting lower incentive compensation.
Core other income decreased by $0.2 million in the six months of 2020.
Income taxes, which principally relate to the taxable nature of our loan servicing and loan conduit businesses and certain other real estate related investing activities which are housed in TRSs, decreased $7.2 million from a provision of $2.3 million to a benefit of $4.9 million due to tax losses of our TRSs in the six months of 2020.
Income attributable to non-controlling interests increased $10.9 million primarily relating to income of a consolidated CMBS joint venture in which we hold a 51% interest.
Core corporate costs and expenses decreased by $7.5 million, from $103.0 million during the six months of 2019 to $95.5 million in the six months of 2020 primarily due to a favorable change in realized gain (loss) on interest rate swaps which hedge a portion of our unsecured senior notes used to repay variable-rate secured financing.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet our cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make new investments where appropriate, pay dividends to our stockholders, and other general business needs. We closely monitor our liquidity position and believe that we have sufficient current liquidity and access to additional liquidity to meet our financial obligations for at least the next 12 months. Our strategy for managing liquidity and capital resources has not changed since December 31, 2019. Refer to our Form 10-K for a description of these strategies. We expect to preserve and build our liquidity to best position the Company to weather near-term market uncertainty, satisfy our loan future funding and financing obligations and to potentially make opportunistic new investments, which will cause us to take some or all of the following actions: raise capital from offerings of securities, borrow additional capital, sell assets, pay our management and incentive fees in shares of our common stock (as was done for the quarter ended March 31, 2020) and/or change our dividend practice, including by reducing the amount of, or temporarily suspending, our future dividends or paying our future dividends in kind for some period of time. We currently expect the pace of loan repayments will slow while the impacts of the COVID-19 pandemic are ongoing.
We are continuing to monitor the COVID-19 pandemic and its impact on us, the borrowers underlying our commercial and residential real estate-related loans and infrastructure loans (and their tenants), the tenants in the properties we own, our financing sources, and the economy as a whole. Because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing and difficult to predict, the pandemic’s impact on our operations and liquidity remains uncertain and difficult to predict. Further discussion of the potential impacts on us from the COVID-19 pandemic is provided in the section entitled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q.
Credit Facilities
During the three months ended June 30, 2020, we entered into agreements with seven of the secured credit facility lenders in our commercial lending portfolio to temporarily suspend credit mark provisions on certain of their portfolio assets in exchange for: (i) cash repayments; (ii) pledges of additional collateral; and (iii) reductions of available borrowings.
We are in frequent, consistent dialogue with the providers of our secured credit facilities regarding our management of their collateral assets in light of the impacts of the COVID-19 pandemic. Our in-house asset management team, along with an experienced team of workout professionals within our special servicer, are skilled in managing loans throughout cycles, which we believe will assist us in achieving maximum resolution on any assets impacted by the COVID-19 pandemic.
No such modifications or agreements were made with lenders on credit facilities related to our property, residential lending or infrastructure lending portfolios.
Our primary sources of liquidity are as follows:
Cash Flows for the Six Months Ended June 30, 2020 (amounts in thousands)
Excluding Investing
GAAP
Adjustments
and Servicing VIEs
Net cash provided by operating activities
(2,049)
767,689
Proceeds from principal collections and sale of loans
1,434,351
(238,506)
Proceeds from sales and collections of investment securities
58,419
61,365
119,784
Net cash flows from other investments and assets
(67,577)
Net cash used in investing activities
(161,021)
(401,777)
(3,730,508)
Proceeds from common stock issuances, net of offering costs
354
2,219
(74,295)
236,336
Net cash used in financing activities
163,240
(416,129)
Net decrease in cash, cash equivalents and restricted cash
(50,217)
(1,221)
572,810
(1,051)
523,080
The discussion below is on a non-GAAP basis, after removing adjustments principally resulting from the consolidation of the securitization VIEs under ASC 810. These adjustments principally relate to (i) the purchase of CMBS, RMBS, loans and real estate from consolidated VIEs, which are reflected as repayments of VIE debt on a GAAP basis and (ii) principal collections of CMBS and RMBS related to consolidated VIEs, which are reflected as VIE distributions on a GAAP basis. There is no significant net impact to cash flows from operations or to overall cash resulting from these consolidations. Refer to Note 2 to the Condensed Consolidated Financial Statements for further discussion.
Cash and cash equivalents decreased by $50.2 million during the six months ended June 30, 2020, reflecting net cash used in investing activities of $401.8 million and net cash used in financing activities of $416.1 million, partially offset by net cash provided by operating activities of $767.7 million.
Net cash provided by operating activities of $767.7 million during the six months ended June 30, 2020 related primarily to proceeds from sales of loans held-for-sale, net of originations and purchases, of $600.2 million and cash interest income of $289.8 million from our loans and $78.2 million from our investment securities. Net rental income provided cash of $88.6 million and servicing fees provided cash of $17.7 million. Offsetting these cash inflows was cash interest expense of $202.6 million, general and administrative expenses of $66.5 million, management fees of $37.0 million and a net change in operating assets and liabilities of $9.0 million.
91
Net cash used in investing activities of $401.8 million during the six months ended June 30, 2020 related primarily to the origination and acquisition of new loans held-for-investment of $1.7 billion, the purchase and funding of investment securities of $238.5 million and net additions to properties and other assets of $13.9 million, partially offset by proceeds received from principal collections and sales of loans of $1.4 billion and investment securities of $119.8 million, proceeds from the sale of real estate of $23.8 million and proceeds from the sale of interest in unconsolidated entities of $10.3 million.
Net cash used in financing activities of $416.1 million during the six months ended June 30, 2020 related primarily to dividend distributions of $271.6 million, net distributions to non-controlling interests of $64.9 million, repayments on our secured debt and deferred loan costs of $51.1 million, net of borrowings, and treasury stock purchases of $28.8 million.
Our Investment Portfolio
The following is a review of our segments for the six months ended June 30, 2020. Refer to the section entitled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q for discussion of the potential impacts on us from the COVID-19 pandemic.
The following table sets forth the amount of each category of investments we owned across various property types within our Commercial and Residential Lending Segment as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Unlevered
Asset Specific
Return on
Investment
Vintage
Asset
First mortgages (1)
8,113,339
8,094,109
4,998,772
3,095,337
1998-2020
Subordinated mortgages
1998-2019
8.6
Mezzanine loans (1)
2013-2020
11.7
Residential loans, fair value option
183,987
83,743
6.0
Other loans
1999-2017
9.9
Loans held-for-sale, fair value option, residential
305,148
127,638
2015-2020
266,539
31,897
142,384
2003-2007
11.4
RMBS, fair value option
266,687
(2)
27,698
300,572
2018-2020
8.5
CMBS, fair value option
110,624
104,171
26,056
78,115
HTM debt securities (3)
508,945
507,994
105,070
402,924
2014-2019
Credit loss allowance
(98,830)
11,333
10,666,033
10,590,956
5,678,628
4,912,328
7,961,494
7,926,732
4,715,244
3,211,488
6.4
9.5
2013-2019
12.2
425,423
246,149
5.9
1999-2018
454,223
151,161
2015-2019
Credit loss allowance, loans
278,853
102,073
87,503
12.3
87,397
32,292
114,742
2018-2019
10.2
118,249
118,215
58,801
59,414
5.5
527,338
525,485
178,880
346,605
7.1
12,119
10,855,507
10,859,445
5,966,936
4,892,509
93
As of June 30, 2020 and December 31, 2019, our Commercial and Residential Lending Segment’s investment portfolio, excluding residential loans, RMBS, properties and other investments, had the following characteristics based on carrying values:
Collateral Property Type
Office
37.2
40.2
Hotel
22.7
20.6
Multifamily
11.9
8.3
8.7
Mixed Use
8.0
Retail
2.9
3.5
Industrial
1.3
7.7
7.0
100.0
Geographic Location
U.S. Regions:
North East
24.7
27.5
West
21.8
22.2
South West
11.1
10.7
Mid Atlantic
South East
7.9
Midwest
4.8
International:
Europe/Australia
17.3
16.2
Bahamas/Bermuda
3.0
The following table sets forth the amount of each category of investments we owned within our Infrastructure Lending Segment as of June 30, 2020 and December 31, 2019 (dollars in thousands):
First priority infrastructure loans and HTM securities
1,547,019
1,518,884
1,184,269
334,615
36,732
8,269
(19,458)
1,593,130
1,569,171
348,170
1,474,052
1,442,601
1,121,065
321,536
96,001
23,723
1,595,323
1,587,991
370,925
As of June 30, 2020 and December 31, 2019, our Infrastructure Lending Segment’s investment portfolio had the following characteristics based on carrying values:
Collateral Type
Natural gas power
70.7
72.6
Midstream
18.1
12.8
Renewable power
10.6
Other thermal power
42.8
43.9
23.4
25.5
15.6
12.6
Mid-Atlantic
Mexico
95
The following table sets forth the amount of each category of investments held within our Property Segment as of June 30, 2020 and December 31, 2019 (amounts in thousands):
Lease intangibles, net
44,986
2,040,260
2,074,010
The following table sets forth our net investment and other information regarding the Property Segment’s properties and lease intangibles as of June 30, 2020 (dollars in thousands):
Specific
Occupancy
Lease Term
Office—Medical Office Portfolio
760,029
591,353
168,676
92.8
6.1 years
Multifamily residential—Woodstar I Portfolio
632,763
571,920
60,843
98.3
0.5 years
Multifamily residential—Woodstar II Portfolio
606,984
436,987
169,997
99.6
Retail—Master Lease Portfolio
343,790
192,558
151,232
21.8 years
Subtotal—undepreciated carrying value
2,343,566
550,748
Accumulated depreciation and amortization
(303,306)
Net carrying value
247,442
As of June 30, 2020 and December 31, 2019, our Property Segment’s investment portfolio had the following geographic characteristics based on carrying values:
62.0
10.1
9.7
96
The following table sets forth the amount of each category of investments we owned within our Investing and Servicing Segment as of June 30, 2020 and December 31, 2019 (amounts in thousands):
2,625,096
363,333
731,280
Intangible assets - servicing rights
48,809
17,620
Loans held-for-sale, fair value option, commercial
133,900
60,197
186,233
12,048
2,817,478
1,601,687
918,221
2,897,654
300,705
876,443
43,164
20,060
85,873
73,365
187,929
22,653
3,059,583
1,643,669
1,069,162
Our REIS Equity Portfolio, as described in Note 6 to the Condensed Consolidated Financial Statements, had the following characteristics based on carrying values of $200.5 million and $214.9 million as of June 30, 2020 and December 31, 2019, respectively:
Property Type
50.0
52.7
30.5
28.8
6.9
Self-storage
2.2
2.3
24.4
22.0
22.6
15.8
15.0
13.5
11.8
8.4
10.9
New Credit Facilities and Amendments
Refer to Notes 9 and 10 of our Condensed Consolidated Financial Statements for a detailed discussion of new credit facilities and amendments to existing credit facilities executed since December 31, 2019.
Secured Borrowings
The following table is a summary of our secured borrowings as of June 30, 2020 (dollars in thousands):
Approved
but
Unallocated
Facility
Outstanding
Undrawn
Size
Balance
Capacity (b)
Amount (c)
439,342
4,717,716
392,331
339,517
215,126
81,526
139,084
520,868
5,803,774
620,667
154,132
787,432
(l)
19,138
(m)
120,000
1,518,500
Collateralized Loan Obligation
Jul 2038
LIBOR + 1.34%
5,459,714
8,187,634
4,967,672
3,099,962
13,236,652
19,402,975
640,868
8,903,736
(82,555)
99
As of June 30, 2020, Wells Fargo Bank, N.A. is our largest repurchase facility creditor through a Commercial Loans repurchase facility and a CMBS/RMBS repurchase facility with aggregate outstanding balances of $723.5 million and pledged asset carrying values of $1.2 billion. These facilities have a weighted average extended maturity of 8.6 years.
Refer to Note 9 of the Condensed Consolidated Financial Statements for further disclosure regarding the terms of our secured financing arrangements.
Variance between Average and Quarter-End Credit Facility Borrowings Outstanding
The following table compares the average amount outstanding under our secured financing agreements during each quarter and the amount outstanding as of the end of each quarter, together with an explanation of significant variances (amounts in thousands):
Weighted-Average
Explanations
Quarter-End
Balance During
for Significant
Quarter Ended
Quarter
Variance
Variances
9,936,500
9,535,839
400,661
March 31, 2020
10,714,680
10,194,276
520,404
10,218,089
(359,718)
Borrowings under Unsecured Senior Notes
During both the three months ended June 30, 2020 and 2019, the weighted average effective borrowing rate on our unsecured senior notes was 4.9%. During both the six months ended June 30, 2020 and 2019, the weighted average effective borrowing rate on our unsecured senior notes was 5.0%. The effective borrowing rate includes the effects of underwriter purchase discount and the adjustment for the conversion option on the Convertible Notes, the initial value of which reduced the balance of the notes.
Refer to Note 10 of our Condensed Consolidated Financial Statements for further disclosure regarding the terms of our unsecured senior notes.
Scheduled Principal Repayments on Investments and Overhang on Financing Facilities
The following scheduled and/or projected principal repayments on our investments were based on amounts outstanding and extended contractual maturities of those investments as of June 30, 2020. The projected and/or required repayments of financing were based on the earlier of (i) the extended contractual maturity of each credit facility or (ii) the extended contractual maturity of each of the investments that have been pledged as collateral under the respective credit facility (amounts in thousands):
Scheduled Principal
Scheduled/Projected
Projected/Required
Repayments on Loans
Principal Repayments
Repayments of
Inflows Net of
and HTM Securities
on RMBS and CMBS
Financing Outflows
Third Quarter 2020
439,103
22,746
(171,651)
290,198
Fourth Quarter 2020
163,676
113,085
(235,288)
41,473
First Quarter 2021
191,084
8,230
(1,267,529)
(1,068,215)
Second Quarter 2021
424,304
9,707
(21,514)
412,497
1,218,167
153,768
(1,695,982)
(324,047)
Issuances of Equity Securities
We may raise funds through capital market transactions by issuing capital stock. There can be no assurance, however, that we will be able to access the capital markets at any particular time or on any particular terms. We have authorized 100,000,000 shares of preferred stock and 500,000,000 shares of common stock. At June 30, 2020, we had 100,000,000 shares of preferred stock available for issuance and 215,532,478 shares of common stock available for issuance.
Other Potential Sources of Financing
In the future, we may also use other sources of financing to fund the acquisition of our target assets, including other secured as well as unsecured forms of borrowing and sale of senior loan interests and other assets.
Repurchases of Equity Securities and Convertible Senior Notes
In February 2020, our board of directors authorized the repurchase of up to $400.0 million of our outstanding common shares and convertible senior notes over a period of one year. Purchases made pursuant to the program will be made in either the open market or in privately negotiated transactions from time to time as permitted by federal securities laws and other legal requirements. The timing, manner, price and amount of any repurchases are discretionary and will be subject to economic and market conditions, stock price, applicable legal requirements and other factors. The program may be suspended or discontinued at any time. During the six months ended June 30, 2020, we repurchased $28.8 million of common stock and no convertible senior notes under the repurchase program. As of June 30, 2020, we have $371.2 million of remaining capacity to repurchase common stock and/or convertible senior notes under the repurchase program.
101
Off-Balance Sheet Arrangements
We have relationships with unconsolidated entities and financial partnerships, such as entities often referred to as VIEs. Our maximum risk of loss associated with our involvement in VIEs is limited to the carrying value of our investment in the entity and any unfunded capital commitments. Refer to Note 14 of the Condensed Consolidated Financial Statements for further discussion.
Dividends
U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We generally intend to distribute substantially all of our taxable income (which does not necessarily equal our GAAP net income) to our stockholders each year, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating and debt service requirements. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. Refer to our Form 10-K for a detailed dividend history.
The Company’s board of directors declared the following dividends during the six months ended June 30, 2020:
Declare Date
Leverage Policies
Our strategies with regards to use of leverage have not changed significantly since December 31, 2019. Refer to our Form 10-K for a description of our strategies regarding use of leverage.
Contractual Obligations and Commitments
Contractual obligations as of June 30, 2020 are as follows (amounts in thousands):
Less than
More than
1 year
1 to 3 years
3 to 5 years
5 years
Secured financings (a)
1,039,604
825,752
4,188,245
2,868,395
Collateralized loan obligations
950,000
Loan and preferred equity interest funding commitments (b)
1,877,333
1,244,077
594,783
38,473
Infrastructure Lending Segment commitments (c)
272,742
224,555
48,187
Future lease commitments
33,192
6,945
6,107
3,491
16,649
13,991,638
3,015,181
2,424,829
4,730,209
3,821,419
The table above does not include interest payable, amounts due under our management agreement, amounts due under our derivative agreements or amounts due under guarantees as those contracts do not have fixed and determinable payments.
Critical Accounting Estimates
Our financial statements are prepared in accordance with GAAP, which requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time made, based upon information available to us at that time. Refer to the section of our Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” for a full discussion of our critical accounting estimates. Except as set forth below, our critical accounting estimates have not materially changed since December 31, 2019.
As discussed in Note 2 to the Condensed Consolidated Financial Statements, ASC 326, Financial Instruments – Credit Losses, became effective for the Company on January 1, 2020. ASC 326 mandates the use of a current expected credit loss model (“CECL”) for estimating future credit losses of certain financial instruments measured at amortized cost, instead of the “incurred loss” credit model previously required under GAAP. The CECL model requires the consideration of possible credit losses over the life of an instrument as opposed to only estimating credit losses upon the occurrence of a discrete loss event under the previous “incurred loss” methodology. The CECL model applies to our loans held-for-investment (“HFI”) and our held-to-maturity (“HTM”) debt securities which are carried at amortized cost, including future funding commitments and accrued interest receivable related to those loans and securities.
103
As we do not have a history of realized credit losses on our HFI loans and HTM securities, we have subscribed to third party database services to provide us with historical industry losses for both commercial real estate and infrastructure loans. Using these losses as a benchmark, we determine expected credit losses for our loans and securities on a collective basis within our commercial real estate and infrastructure portfolios. Such determination also incorporates significant assumptions and estimates regarding, among other things, prepayments, future fundings and economic forecasts. See Note 4 to the Condensed Consolidated Financial Statements for further discussion of our methodologies.
Significant judgment is required when estimating future credit losses; therefore, actual results over time could be materially different. As of June 30, 2020, we held $10.7 billion of loans and HTM securities measured at amortized cost with expected future funding commitments of $2.0 billion. We recognized a provision for credit losses with respect to those loans and securities and expected future funding commitments of $10.2 million and $58.9 million during the three and six months ended June 30, 2020, respectively, and the related credit loss allowance was $127.5 million as of June 30, 2020.
Separate provisions of ASC 326 apply to our available-for-sale (“AFS”) debt securities which are carried at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income (“AOCI”). We are required to establish an initial credit loss allowance for those securities that are purchased with credit deterioration by grossing up the amortized cost basis of each security and providing an offsetting credit loss allowance for the difference between expected cash flows and contractual cash flows, both on a present value basis.
Subsequently, cumulative adverse changes in expected cash flows on our available-for-sale debt securities are recognized currently as an increase to the credit loss allowance. However, the allowance is limited to the amount by which the AFS debt security’s amortized cost exceeds its fair value. Favorable changes in expected cash flows are first recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Such changes would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero. A change in expected cash flows that is attributable solely to a change in a variable interest reference rate does not result in a credit loss and is accounted for as a prospective yield adjustment.
Significant judgment is required when estimating expected cash flows used in determining the credit loss allowance for AFS debt securities; therefore, actual results over time could be materially different. As of June 30, 2020, we held $174.3 million of AFS debt securities. We did not recognize any provision for credit losses with respect to our AFS debt securities during the three and six months ended June 30, 2020 and there was no related credit loss allowance as of June 30, 2020.
104
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake. Our strategies for managing risk and our exposure to such risks, as described in Item 7A of our Form 10-K, have not changed materially since December 31, 2019 except as described below. However, many of those risks have been magnified due to the continuing economic disruptions caused by the COVID-19 pandemic.
Credit Risk
Our loans and investments are subject to credit risk. The performance and value of our loans and investments depend upon the owners’ ability to operate the properties that serve as our collateral so that they produce cash flows adequate to pay interest and principal due to us. To monitor this risk, our asset management team reviews our investment portfolios and is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary.
We seek to further manage credit risk associated with our Investing and Servicing Segment loans held-for-sale through the purchase of credit index instruments. The following table presents our credit index instruments as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Face Value of
Aggregate Notional Value of
Number of
Loans Held-for-Sale
Credit Index Instruments
89,000
The COVID-19 pandemic has significantly impacted the commercial real estate markets, causing reduced occupancy, requests from tenants for rent deferral or abatement, and delays in construction and development and infrastructure projects currently planned or underway. These negative conditions have continued, and may continue into the future and impair our borrowers’ ability to pay principal and interest due to us under our loan agreements and our tenants’ ability to pay rent under various lease arrangements.
As discussed above, our asset management team reviews our investment portfolios and is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary. We have utilized these relationships to address the potential impacts of the COVID-19 pandemic to the assets which secure our loans, particularly hospitality assets. Some of our borrowers have indicated that due to the impact of the COVID-19 pandemic, they will be unable to timely execute their business plans, have had to temporarily close their businesses, or have experienced other negative business consequences which have led to cash flow pressures at the underlying properties. In some cases, these borrowers have requested temporary interest deferral or forbearance, or other modifications of their loans.
Discussions we have had with our borrowers and tenants have addressed potential near-term defensive loan or lease modifications, which could include repurposing of reserves, temporary deferrals of interest, or performance test or covenant waivers on loans collateralized by assets directly impacted by the COVID-19 pandemic.
As discussed above, we have granted loan modifications to certain of our borrowers. Although we continue to believe that the principal amounts of our assets are generally adequately protected by underlying collateral value, there is a risk that we will not realize the entire principal value of certain investments.
Capital Market Risk
We are exposed to risks related to the equity capital markets and our related ability to raise capital through the issuance of our common stock or other equity instruments. We are also exposed to risks related to the debt capital markets, and our related ability to finance our business through borrowings under repurchase obligations or other debt instruments. As a REIT, we are required to distribute a significant portion of our taxable income annually, which
constrains our ability to accumulate operating cash flow and therefore requires us to utilize debt or equity capital to finance our business. We seek to mitigate these risks by monitoring the debt and equity capital markets to inform our decisions on the amount, timing and terms of capital we raise.
The COVID-19 pandemic has also resulted in extreme volatility in a variety of global markets, including the real estate-related debt markets. We may receive margin calls from our lenders as a result of the decline in the market value of the loans or other assets pledged by us to our lenders under our repurchase agreements and warehouse credit facilities, and if we fail to resolve such margin calls when due by payment of cash or delivery of additional collateral, the lenders may exercise remedies including demanding payment by us of our aggregate outstanding financing obligations and/or taking ownership of the loans or other assets securing the applicable obligations.
Interest Rate Risk
Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our investments and the related financing obligations. In general, we seek to match the interest rate characteristics of our investments with the interest rate characteristics of any related financing obligations such as repurchase agreements, bank credit facilities, term loans, revolving facilities and securitizations. In instances where the interest rate characteristics of an investment and the related financing obligation are not matched, we mitigate such interest rate risk through the utilization of interest rate derivatives of the same duration. The following table presents financial instruments where we have utilized interest rate derivatives to hedge interest rate risk and the related interest rate derivatives as of June 30, 2020 and December 31, 2019 (dollars in thousands):
Aggregate Notional
Value of Interest
Number of Interest
Hedged Instruments
Rate Derivatives
Instrument hedged as of June 30, 2020
Loans held-for-investment, residential
87,800
621,195
672,900
421,000
152,217
71,000
17,573
Secured financing agreements
920,891
1,640,311
3,238,958
3,880,584
Instrument hedged as of December 31, 2019
169,200
747,779
344,900
85,000
18,784
693,496
1,423,881
3,393,837
3,011,765
106
The following table summarizes the estimated annual change in net investment income for our variable rate investments and our variable rate debt assuming increases or decreases in LIBOR or other applicable index rates and adjusted for the effects of our interest rate hedging activities (amounts in thousands, except per share data):
Variable rate
investments and
1.0%
0.5%
Income (Expense) Subject to Interest Rate Sensitivity
indebtedness (1)
Increase
Decrease
Investment income from variable rate investments
10,151,307
37,508
15,215
(6,023)
(8,225)
Interest expense from variable rate debt, net of interest rate derivatives
(6,196,744)
(68,632)
(34,013)
10,980
Net investment income from variable rate instruments
3,954,563
(31,124)
(18,798)
4,957
3,226
Impact per diluted shares outstanding
(0.11)
(0.07)
LIBOR Transition Risk
In July 2017, the United Kingdom’s Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. There is currently no certainty regarding the future utilization of LIBOR or of any particular replacement rate (although the secured overnight financing rate has been proposed as an alternative to U.S.-dollar LIBOR). As indicated in the Interest Rate Risk section above, a substantial portion of our loans, investment securities, borrowings and interest rate derivatives are indexed to LIBOR or similar reference rates. Market participants anticipate that financial instruments tied to LIBOR will require transition to an alternative reference rate if LIBOR is no longer available. Our LIBOR-based loan agreements and borrowing arrangements generally specify alternative reference rates such as the prime rate and federal funds rate, respectively. The potential effect of the discontinuation of LIBOR on our interest income and expense cannot yet be determined and any changes to benchmark interest rates could increase our financing costs and/or result in mismatches between the interest rates of our investments and the corresponding financings.
Foreign Currency Risk
We intend to hedge our currency exposures in a prudent manner. However, our currency hedging strategies may not eliminate all of our currency risk due to, among other things, uncertainties in the timing and/or amount of payments received on the related investments, and/or unequal, inaccurate, or unavailable hedges to perfectly offset changes in future exchange rates. Additionally, we may be required under certain circumstances to collateralize our currency hedges for the benefit of the hedge counterparty, which could adversely affect our liquidity.
Consistent with our strategy of hedging foreign currency exposure on certain investments, we typically enter into a series of forwards to fix the U.S. dollar amount of foreign currency denominated cash flows (interest income, rental income and principal payments) we expect to receive from our foreign currency denominated investments. Accordingly, the notional values and expiration dates of our foreign currency hedges approximate the amounts and timing of future payments we expect to receive on the related investments.
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The following table represents our current currency hedge exposure as it relates to our investments denominated in foreign currencies, along with the aggregate notional amount of the hedges in place (amounts in thousands except for number of contracts) using the June 30, 2020 GBP closing rate of 1.2399, EUR closing rate of 1.1235 and AUD closing rate of 0.6902.
Carrying Value of Net Investment
Local Currency
Number of Foreign Exchange Contracts
Aggregate Notional Value of Hedges Applied
Expiration Range of Contracts
48,803
55,167
November 2021
17,564
27,960
19,088
132
18,231
August 2020 – July 2021
28,521
35,257
July 2023
72,432
78,762
July 2020 – January 2022
48,568
52,437
August 2020 – July 2022
25,916
30,317
August 2020 – August 2022
89,547
98,871
65,914
57,651
April 2021
5,531
6,892
November 2020 – July 2022
11,179
13,899
1,917
3,908
August 2021
23,641
30,706
August 2020 – June 2023
38,312
59,539
August 2020 – November 2022
39,122
48,987
September 2020 – November 2025
55,131
66,056
August 2020 – November 2021
8,605
11,207
June 2022
12,622
September 2020 – April 2022
609,582
385
708,469
Real Estate Risk
The market values of commercial and residential mortgage assets are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, the impacts of the COVID-19 pandemic discussed above, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions; changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay the underlying loans, which could also cause us to suffer losses.
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Item 4. Controls and Procedures.
Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosures.
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control Over Financial Reporting. No change in internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
Currently, no material legal proceedings are pending or, to our knowledge, threatened or contemplated against us, that could have a material adverse effect on our business, financial position or results of operations.
Item 1A. Risk Factors.
Except as set forth in our Quarterly Report on Form 10-Q for the period ended March 31, 2020, as updated below, there have been no material changes to the risk factors previously disclosed in our Form 10-K.
Risks Related to Our Company
The global COVID-19 pandemic is having, and will likely continue to have, an adverse impact on our operations and financial performance, as well as on the operations and financial performance of many of the borrowers underlying our real estate-related assets and tenants of our owned properties. We are unable to predict the extent to which the pandemic and related impacts will continue to adversely impact our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders.
Our operations and financial performance have been negatively impacted by the COVID-19 pandemic that has caused, and is expected to continue to cause, the global slowdown of economic activity and significant volatility and disruption of financial markets. Because the severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing and difficult to predict, the pandemic’s impact on our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders, remains uncertain and difficult to predict. Further, the ultimate impact of the COVID-19 pandemic on our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders depends on many factors that are not within our control, including, but not limited, to: governmental, business and individuals’ actions that have been and continue to be taken in response to the pandemic (including quarantine and “stay-at-home” orders, restrictions on travel and transport, school closures, limits on the operations of non-essential businesses and other workforce pressures); the impact of the pandemic, and actions taken in response thereto, on global and regional economies and economic activity, including concerns regarding additional surges of the pandemic or the expansion of the economic impact thereof as a result of certain jurisdictions “re-opening” or otherwise lifting certain restrictions prematurely; the availability of U.S. federal, state, local or non-U.S. funding programs aimed at supporting the economy during the COVID 19-pandemic, including uncertainties regarding the potential implementation of new or extended programs; general economic uncertainty in key global markets and financial market volatility; global economic conditions and levels of economic growth; and the pace of recovery when the COVID-19 pandemic subsides.
The COVID-19 pandemic and “stay-at-home” and other measures implemented to prevent its spread and any extended period of economic slowdown or recession could have a material adverse effect on our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders, among other matters. We expect that these adverse effects are likely to continue as long as the outbreak persists and potentially even longer. Although it is difficult to predict the magnitude of the business and economic implications, the COVID-19 outbreak could affect us in various ways, including, among other factors:
We have been engaged in discussions with our borrowers, some of whom have indicated that, due to the impact of the COVID-19 pandemic, they have been unable to timely execute their business plans, have had to temporarily close their businesses or have experienced other negative business consequences and have requested or indicated that they will be requesting interest or principal deferral or other modifications of their loans. We therefore anticipate more frequent modifications of our loans and potentially instances of default or foreclosure on assets underlying our loans.
To the extent that borrowers that have been negatively impacted by the COVID-19 pandemic do not timely remit payments of principal and interest relating to their respective real estate-related assets, the value of such assets will likely be impaired, potentially materially. Failure to receive interest when due may adversely affect our liquidity and therefore our ability to fund our operations or address maturing liabilities on a timely basis.
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The adverse impact of the COVID-19 pandemic could adversely affect our liquidity position and could limit our ability to grow our business and fully execute our business strategy. We expect to preserve and build our liquidity to best position the Company to weather near-term market uncertainty, satisfy our loan future funding and financing obligations and to potentially make opportunistic new investments, which will cause us to take some or all of the following actions: raise capital from offerings of securities, borrow additional capital, sell assets, pay our management and incentive fees in shares of our common stock (as was done for the quarter ended March 31, 2020) and/or change our dividend practice, including by reducing the amount of, or temporarily suspending, our future dividends or paying our future dividends in kind for some period of time.
To the extent the COVID-19 pandemic adversely affects our business, financial condition, results of operations, liquidity, the market price of our common stock and our ability to make distributions to our stockholders, it may also have the effect of heightening many of the other risks described in the Form 10-K under the heading “Risk Factors.”
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
There were no unregistered sales of securities during the three months ended June 30, 2020.
Issuer Purchases of Equity Securities
There were no purchases of common stock during the three months ended June 30, 2020.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Item 6. Exhibits.
Index to Exhibits
INDEX TO EXHIBITS
Exhibit No.
Description
31.1
Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2
32.1
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
101.INS
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File (embedded within the Inline XBRL document)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
STARWOOD PROPERTY TRUST, INC.
Date: August 5, 2020
By:
/s/ BARRY S. STERNLICHT
Barry S. Sternlicht Chief Executive Officer Principal Executive Officer
/s/ RINA PANIRY
Rina Paniry Chief Financial Officer, Treasurer, Chief Accounting Officer and Principal Financial Officer