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 March 31, 2019
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
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 ☒
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
The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of May 2, 2019 was 280,296,261.
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:
·
factors described in our Annual Report on Form 10-K for the year ended December 31, 2018 and this Quarterly Report on Form 10-Q, including those set forth under the captions “Risk Factors” and “Business”;
defaults by borrowers in paying debt service on outstanding indebtedness;
impairment in the value of real estate property securing our loans or in which we invest;
availability of mortgage origination and acquisition opportunities acceptable to us;
potential mismatches in the timing of asset repayments and the maturity of the associated financing agreements;
our ability to integrate our recently completed acquisition of the project finance origination, underwriting and capital markets business of GE Capital Global Holdings, LLC into our business and to achieve the benefits that we anticipate from the acquisition;
national and local economic and business conditions;
general and local commercial and residential real estate property conditions;
changes in federal government policies;
changes in federal, state and local governmental laws and regulations;
increased competition from entities engaged in mortgage lending and securities investing activities;
changes in interest rates; and
the availability of, and costs associated with, sources of liquidity.
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.
2
TABLE OF CONTENTS
Page
Part I
Financial Information
Item 1.
Financial Statements
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Comprehensive Income
Condensed Consolidated Statements of Equity
Condensed Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Note 1 Business and Organization
Note 2 Summary of Significant Accounting Policies
Note 3 Acquisitions
Note 4 Loans
Note 5 Investment Securities
Note 6 Properties
Note 7 Investment in Unconsolidated Entities
Note 8 Goodwill and Intangibles
Note 9 Secured Financing Agreements
Note 10 Unsecured Senior Notes
Note 11 Loan Securitization/Sale Activities
Note 12 Derivatives and Hedging Activity
Note 13 Offsetting Assets and Liabilities
Note 14 Variable Interest Entities
Note 15 Related-Party Transactions
Note 16 Stockholders’ Equity and Non-Controlling Interests
Note 17 Earnings per Share
Note 18 Accumulated Other Comprehensive Income
Note 19 Fair Value
Note 20 Income Taxes
Note 21 Commitments and Contingencies
Note 22 Segment Data
Note 23 Subsequent Events
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
Part II
Other Information
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Item 6.
Exhibits
3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Starwood Property Trust, Inc. and Subsidiaries
(Unaudited, amounts in thousands, except share data)
As of
March 31, 2019
December 31, 2018
Assets:
Cash and cash equivalents
$
412,270
239,824
Restricted cash
133,714
248,041
Loans held-for-investment, net
8,964,725
8,532,356
Loans held-for-sale ($841,687 and $671,282 held at fair value)
1,144,490
1,187,552
Loans transferred as secured borrowings
—
74,346
Investment securities ($266,446 and $262,319 held at fair value)
910,233
906,468
Properties, net
2,769,374
2,784,890
Intangible assets ($19,790 and $20,557 held at fair value)
136,835
145,033
Investment in unconsolidated entities
124,360
171,765
Goodwill
259,846
Derivative assets
47,410
52,691
Accrued interest receivable
60,314
60,355
Other assets
227,153
152,922
Variable interest entity (“VIE”) assets, at fair value
56,974,864
53,446,364
Total Assets
72,165,588
68,262,453
Liabilities and Equity
Liabilities:
Accounts payable, accrued expenses and other liabilities
193,143
217,663
Related-party payable
23,945
44,043
Dividends payable
135,889
133,466
Derivative liabilities
10,163
15,415
Secured financing agreements, net
9,234,910
8,683,565
Unsecured senior notes, net
1,922,795
1,998,831
Secured borrowings on transferred loans, net
74,239
VIE liabilities, at fair value
55,727,776
52,195,042
Total Liabilities
67,248,621
63,362,264
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, 285,481,485 issued and 280,301,345 outstanding as of March 31, 2019 and 280,839,692 issued and 275,659,552 outstanding as of December 31, 2018
2,855
2,808
Additional paid-in capital
5,080,173
4,995,156
Treasury stock (5,180,140 shares)
(104,194)
Accumulated other comprehensive income
55,798
58,660
Accumulated deficit
(413,553)
(348,998)
Total Starwood Property Trust, Inc. Stockholders’ Equity
4,621,079
4,603,432
Non-controlling interests in consolidated subsidiaries
295,888
296,757
Total Equity
4,916,967
4,900,189
Total Liabilities and Equity
See notes to condensed consolidated financial statements.
4
(Unaudited, amounts in thousands, except per share data)
For the Three Months Ended
March 31,
2019
2018
Revenues:
Interest income from loans
183,416
137,620
Interest income from investment securities
17,632
15,269
Servicing fees
24,433
26,067
Rental income
83,833
81,110
Other revenues
1,166
521
Total revenues
310,480
260,587
Costs and expenses:
Management fees
23,466
30,642
Interest expense
134,672
87,183
General and administrative
34,930
32,142
Acquisition and investment pursuit costs
342
377
Costs of rental operations
29,651
29,693
Depreciation and amortization
29,254
31,744
Loan loss provision, net
763
1,538
Other expense
211
104
Total costs and expenses
253,289
213,423
Other income (loss):
Change in net assets related to consolidated VIEs
47,836
52,653
Change in fair value of servicing rights
(767)
(5,814)
Change in fair value of investment securities, net
62
(149)
Change in fair value of mortgage loans held-for-sale, net
11,266
7,800
Loss from unconsolidated entities
(43,200)
(1,462)
Gain on sale of investments and other assets, net
4,485
10,660
Loss on derivative financial instruments, net
(2,207)
(16,859)
Foreign currency gain, net
5,547
13,549
Loss on extinguishment of debt
(3,298)
Other (loss) income, net
(73)
108
Total other income
19,651
60,486
Income before income taxes
76,842
107,650
Income tax provision
(334)
(2,856)
Net income
76,508
104,794
Net income attributable to non-controlling interests
(6,125)
(4,862)
Net income attributable to Starwood Property Trust, Inc.
70,383
99,932
Earnings per share data attributable to Starwood Property Trust, Inc.:
Basic
Diluted
5
(Unaudited, amounts in thousands)
Other comprehensive (loss) income (net change by component):
Cash flow hedges
Available-for-sale securities
(387)
1,163
Foreign currency translation
(2,475)
4,218
Other comprehensive (loss) income
(2,862)
5,386
Comprehensive income
73,646
110,180
Less: Comprehensive income attributable to non-controlling interests
Comprehensive income attributable to Starwood Property Trust, Inc.
67,521
105,318
6
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, January 1, 2019
280,839,692
5,180,140
Proceeds from DRIP Plan
7,825
167
Equity offering costs
(5)
Conversion of 2019 Convertible Notes
3,611,918
36
67,526
67,562
Share-based compensation
526,687
6,357
6,363
Manager incentive fee paid in stock
495,363
10,972
10,977
6,125
Dividends declared, $0.48 per share
(134,938)
Other comprehensive loss, net
VIE non-controlling interests
(137)
Contributions from non-controlling interests
95
Distributions to non-controlling interests
(6,952)
Balance, March 31, 2019
285,481,485
Balance, January 1, 2018
265,983,309
2,660
4,715,246
4,606,885
(92,104)
(217,312)
69,924
4,478,414
100,787
4,579,201
7,651
159
Common stock repurchased
573,255
(12,090)
598,701
4,762
4,768
545,641
10,978
10,983
4,862
(126,058)
Other comprehensive income, net
569
366,691
(2,962)
(226,435)
(229,397)
Sale of controlling interest in majority owned property asset
(319)
Balance, March 31, 2018
267,135,302
2,671
4,728,183
(243,438)
75,310
4,458,532
246,155
4,704,687
7
Cash Flows from Operating Activities:
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Amortization of deferred financing costs, premiums and discounts on secured financing agreements and secured borrowings on transferred loans
9,183
5,167
Amortization of discounts and deferred financing costs on senior notes
1,933
3,869
Accretion of net discount on investment securities
(2,755)
(6,841)
Accretion of net deferred loan fees and discounts
(7,526)
(12,052)
Share-based component of incentive fees
Change in fair value of investment securities
(62)
149
Change in fair value of consolidated VIEs
133
(11,241)
767
5,814
Change in fair value of loans held-for-sale
(11,266)
(7,800)
Change in fair value of derivatives
3,396
18,069
(5,547)
(13,540)
Gain on sale of investments and other assets
(4,485)
(10,660)
Impairment charges on properties and related intangibles
120
25
28,889
31,412
43,200
1,462
Distributions of earnings from unconsolidated entities
3,661
2,675
3,298
Origination and purchase of loans held-for-sale, net of principal collections
(719,589)
(245,027)
Proceeds from sale of loans held-for-sale
561,702
266,632
Changes in operating assets and liabilities:
Related-party payable, net
(20,098)
(10,588)
Accrued and capitalized interest receivable, less purchased interest
(22,536)
(9,412)
(26,760)
(6,188)
(22,987)
(31,612)
Net cash (used in) provided by operating activities
(92,718)
92,396
Cash Flows from Investing Activities:
Origination and purchase of loans held-for-investment
(1,287,001)
(900,937)
Proceeds from principal collections on loans
556,058
870,400
Proceeds from loans sold
500,271
145,273
Proceeds from sales of investment securities
3,228
Proceeds from principal collections on investment securities
7,754
219,230
Proceeds from sales and insurance recoveries on properties
1,463
51,093
Purchases and additions to properties and other assets
(8,526)
(7,056)
(510)
Distribution of capital from unconsolidated entities
886
21,255
Payments for purchase or termination of derivatives
(3,896)
(15,604)
Proceeds from termination of derivatives
692
11,773
Net cash (used in) provided by investing activities
(229,581)
395,427
8
Condensed Consolidated Statements of Cash Flows (Continued)
Cash Flows from Financing Activities:
Proceeds from borrowings
2,310,902
1,515,241
Principal repayments on and repurchases of borrowings
(1,778,819)
(1,629,449)
Payment of deferred financing costs
(4,706)
(10,506)
Proceeds from common stock issuances
Payment of equity offering costs
Payment of dividends
(132,515)
(125,730)
310
Purchase of treasury stock
Issuance of debt of consolidated VIEs
33,678
7,948
Repayment of debt of consolidated VIEs
(52,856)
(57,289)
Distributions of cash from consolidated VIEs
11,683
13,730
Net cash provided by (used in) financing activities
380,672
(527,073)
Net increase (decrease) in cash, cash equivalents and restricted cash
58,373
(39,250)
Cash, cash equivalents and restricted cash, beginning of period
487,865
418,273
Effect of exchange rate changes on cash
(254)
398
Cash, cash equivalents and restricted cash, end of period
545,984
379,421
Supplemental disclosure of cash flow information:
Cash paid for interest
129,349
75,696
Income taxes paid
484
880
Supplemental disclosure of non-cash investing and financing activities:
Dividends declared, but not yet paid
134,953
126,058
Consolidation of VIEs (VIE asset/liability additions)
3,280,065
1,089,881
Deconsolidation of VIEs (VIE asset/liability reductions)
45,910
875,240
Settlement of 2019 Convertible Notes in shares
75,525
Settlement of loans transferred as secured borrowings
74,692
Unsettled infrastructure loan sales
68,564
Net assets acquired through foreclosure
8,963
Net assets acquired from consolidated VIEs
27,737
Contribution of Woodstar II Portfolio net assets from non-controlling interests
366,381
Loan principal collections temporarily held at master servicer
326,362
9
As of March 31, 2019
(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 March 31, 2019 and we refer to the investments within these segments as our target assets:
Real estate commercial and residential lending (the “Commercial and Residential Lending Segment”)—engages primarily in originating, acquiring, financing and managing commercial and residential first mortgages, subordinated mortgages, mezzanine loans, preferred equity, commercial mortgage-backed securities (“CMBS”), residential mortgage-backed securities (“RMBS”) and other real estate and real estate-related debt investments in both the U.S. and Europe (including distressed or non-performing loans).
Infrastructure lending (the “Infrastructure Lending Segment”)—engages primarily in originating, acquiring, financing and managing infrastructure debt investments.
Real estate property (the “Property Segment”)—engages primarily in acquiring and managing equity interests in stabilized commercial real estate properties, including multifamily properties and commercial properties subject to net leases, that are held for investment.
Real estate investing and servicing (the “Investing and Servicing Segment”)—includes (i) a servicing business in the U.S. that manages and works out problem assets, (ii) an investment business that selectively acquires and manages unrated, investment grade and non-investment grade rated CMBS, including subordinated interests of securitization and resecuritization transactions, (iii) a mortgage loan business which originates conduit loans for the primary purpose of selling these loans into securitization transactions and (iv) an investment business that selectively acquires commercial real estate assets, including properties acquired from CMBS trusts.
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.
10
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, 2018 (our “Form 10-K”), as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2019 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, 2018 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, certain other entities in which we hold interests are considered VIEs as the limited partners of these 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.
11
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.
12
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 nonperformance 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 2% of our consolidated securitization VIE assets, with the remaining 98% 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 eligible financial assets and liabilities of our consolidated securitization VIEs, 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 mortgage loans held-for-sale were made due to the expected short-term holding period of these instruments.
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
13
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 deemed impaired.
Loan Impairment
We evaluate each loan classified as held-for-investment for impairment at least quarterly. Impairment 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. If a loan is considered to be impaired, we record an allowance through the provision for loan losses to reduce the carrying value of the loan to the present value of expected future cash flows discounted at the loan’s contractual effective rate or the fair value of the collateral, if repayment is expected solely from the collateral.
There may be circumstances where we modify a loan by granting the borrower a concession that we might not otherwise consider when a borrower is experiencing financial difficulty or is expected to experience financial difficulty in the foreseeable future. Such concessionary modifications are classified as troubled debt restructurings (“TDRs”) unless the modification solely results in a delay in payment that is insignificant. Loans classified as TDRs are considered impaired loans for reporting and measurement purposes.
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.
Leases
On January 1, 2019, ASC 842, Leases, became effective for the Company. ASC 842 establishes a right-of-use model for lessee accounting which results in the recognition of most leased assets and lease liabilities on the balance sheet of the lessee. Lessor accounting was not significantly affected by this ASC. We elected to apply the provisions of ASC 842 as of January 1, 2019 and not to retrospectively adjust prior periods presented. Such application did not result in any cumulative-effect adjustment as of January 1, 2019. We elected the “package of practical expedients” for transition purposes, which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs for leases that commenced prior to January 1, 2019. We also elected not to apply the recognition provisions of ASC 842 to short-term leases, which have original lease terms of 12 months or less. As a lessor, we elected not to separate nonlease components, such as reimbursements from tenants for common area maintenance (“CAM”), from lease components for all classes of underlying assets, and continue to recognize such nonlease components ratably in rental income. We also elected to continue to exclude from rental income all sales, use and other similar taxes collected from lessees. As required by ASC 842, we no longer record as revenues and expenses lessor costs (such as property taxes) paid directly by the lessees. The application of ASC 842 has had no material effect on our consolidated financial statements, as all of our leases, as both lessor and lessee, are currently classified as operating leases, which are subject to essentially the same straight-line revenue and expense recognition as in the past. As a lessee, our only significant long-term lease resulted in the recognition of a lease liability and corresponding right-of-use asset of $12.0 million as of January 1, 2019, which are classified within accounts payable, accrued expenses and other liabilities and other assets, respectively, in our condensed consolidated balance sheet as of March 31, 2019.
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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 (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 months ended March 31, 2019 and 2018, 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. Actual results could differ from those estimates. The most significant and subjective estimate that we make is the projection of cash flows we expect to receive on our loans, investment securities and intangible assets, which has a significant impact on the amounts of interest income, credit losses (if any) and fair values 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.
Recent Accounting Developments
On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments, which mandates use of an “expected loss” credit model for estimating future credit losses of certain financial instruments instead of the “incurred loss” credit model that current GAAP requires. The “expected loss” 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 in accordance with the current “incurred loss” methodology. This ASU is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2019. Though we have not completed our assessment of this ASU, we expect this ASU to result in our recognition of higher levels of allowances for loan losses. Our assessment of the estimated amount of such increases remains in process.
On January 26, 2017, the FASB issued ASU 2017-04, Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment, which simplifies the method applied for measuring impairment in cases where goodwill is impaired. This ASU specifies that goodwill impairment will 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. This ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2019 and is applied prospectively. Early application is permitted. We do not expect the application of this ASU to materially impact the Company.
On August 28, 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework, which adds new disclosure requirements and modifies or eliminates existing disclosure requirements of ASC 820. This ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2019. Early application is permitted. We do not expect the application of this ASU to materially impact the Company, as it only affects fair value disclosures.
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On October 31, 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810) – Targeted Improvements to Related Party Guidance for Variable Interest Entities, which requires reporting entities to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety for determining whether a decision-making fee is a variable interest. This ASU is effective for annual periods, and interim periods therein, beginning after December 15, 2019. Early application is permitted. We are in the process of assessing the impact this ASU will have on the Company, but do not expect it to be material.
3. Acquisitions
During the three months ended March 31, 2019, we had no significant acquisitions or divestitures of properties or businesses and no measurement period adjustments related to a prior year business combination.
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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. The following tables summarize our investments in mortgages and loans by subordination class as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Weighted
Average Life
Carrying
Face
Average
(“WAL”)
Coupon
(years)(1)
First mortgages (2)
6,851,837
6,874,524
6.7
%
2.1
First priority infrastructure loans
1,450,097
1,460,758
5.8
5.1
Subordinated mortgages (3)
52,849
54,042
8.9
3.5
Mezzanine loans (2)
579,496
581,557
11.6
1.7
61,234
64,916
8.2
2.2
Total loans held-for-investment
8,995,513
9,035,797
Loans held-for-sale, fair value option, residential
688,435
673,249
6.2
Loans held-for-sale, fair value option, commercial
153,252
149,428
4.7
10.0
Loans held-for-sale, infrastructure
303,577
312,551
4.1
1.1
Total gross loans
Loan loss allowance
(31,562)
Total net loans
6,607,117
6,631,236
6.9
2.0
1,456,779
1,465,828
5.7
4.5
52,778
53,996
3.7
393,832
394,739
10.6
61,001
64,658
2.5
8,571,507
8,610,457
623,660
609,571
6.3
6.6
Loans held-for-sale, commercial ($47,622 under fair value option)
94,117
94,916
5.4
469,775
486,909
0.3
7.1
1.3
9,833,405
9,876,545
(39,151)
9,794,254
(1)
Represents the WAL of each respective group of loans as of the respective balance sheet date. The WAL of each individual loan is calculated using amounts and timing of future principal payments, as projected at origination or acquisition.
(2)
First mortgages include first mortgage loans and any contiguous mezzanine loan components because as a whole, the expected credit quality of these loans is more similar to that of a first mortgage loan. The application of this methodology resulted in mezzanine loans with carrying values of $912.8 million and $1.0 billion being classified as first mortgages as of March 31, 2019 and December 31, 2018, respectively.
(3)
Subordinated mortgages include B-Notes and junior participation in first mortgages where we do not own the senior A-Note or senior participation. If we own both the A-Note and B-Note, we categorize the loan as a first mortgage loan.
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As of March 31, 2019, approximately $8.5 billion, or 94.3%, of our loans held-for-investment were variable rate and paid interest principally at LIBOR plus a weighted-average spread of 4.4%.
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 impairment 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.
Our evaluation process, as described above, produces an internal risk rating between 1 and 5, which is a weighted average of the numerical ratings in the following categories: (i) sponsor capability and financial condition, (ii) loan and collateral performance relative to underwriting, (iii) quality and stability of collateral cash flows and (iv) loan structure. We utilize the overall risk ratings as a concise means to monitor any credit migration on a loan as well as on the whole portfolio. While the overall risk rating is generally not the sole factor we use in determining whether a loan is impaired, a loan with a higher overall risk rating would tend to have more adverse indicators of impairment and therefore would be more likely to experience a credit loss.
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The rating categories for commercial real estate loans generally include the characteristics described below, but these are utilized as guidelines and therefore not every loan will have all of the characteristics described in each category:
Rating
Characteristics
1
Sponsor capability and financial condition—Sponsor is highly rated or investment grade or, if private, the equivalent thereof with significant management experience.
Loan collateral and performance relative to underwriting—The collateral has surpassed underwritten expectations.
Quality and stability of collateral cash flows—Occupancy is stabilized, the property has had a history of consistently high occupancy, and the property has a diverse and high quality tenant mix.
Loan structure—Loan to collateral value ratio (“LTV”) does not exceed 65%. The loan has structural features that enhance the credit profile.
Sponsor capability and financial condition—Strong sponsorship with experienced management team and a responsibly leveraged portfolio.
Loan collateral and performance relative to underwriting—Collateral performance equals or exceeds underwritten expectations and covenants and performance criteria are being met or exceeded.
Quality and stability of collateral cash flows—Occupancy is stabilized with a diverse tenant mix.
Loan structure—LTV does not exceed 70% and unique property risks are mitigated by structural features.
Sponsor capability and financial condition—Sponsor has historically met its credit obligations, routinely pays off loans at maturity, and has a capable management team.
Loan collateral and performance relative to underwriting—Property performance is consistent with underwritten expectations.
Quality and stability of collateral cash flows—Occupancy is stabilized, near stabilized, or is on track with underwriting.
Loan structure—LTV does not exceed 80%.
Sponsor capability and financial condition—Sponsor credit history includes missed payments, past due payment, and maturity extensions. Management team is capable but thin.
Loan collateral and performance relative to underwriting—Property performance lags behind underwritten expectations. Performance criteria and loan covenants have required occasional waivers. A sale of the property may be necessary in order for the borrower to pay off the loan at maturity.
Quality and stability of collateral cash flows—Occupancy is not stabilized and the property has a large amount of rollover.
Loan structure—LTV is 80% to 90%.
Sponsor capability and financial condition—Credit history includes defaults, deeds‑in‑lieu, foreclosures, and/or bankruptcies.
Loan collateral and performance relative to underwriting—Property performance is significantly worse than underwritten expectations. The loan is not in compliance with loan covenants and performance criteria and may be in default. Sale proceeds would not be sufficient to pay off the loan at maturity.
Quality and stability of collateral cash flows—The property has material vacancy and significant rollover of remaining tenants.
Loan structure—LTV exceeds 90%.
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The risk ratings for loans subject to our rating system, which excludes loans held-for-sale, by class of loan were as follows as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Balance Sheet Classification
Loans Held-For-Investment
Loans
First Priority
Transferred
% of
Risk Rating
First
Infrastructure
Subordinated
Mezzanine
As Secured
Category
Mortgages
Borrowings
2,723
23,515
26,238
3,329,423
7,354
275,415
3,612,192
35.6
3,289,028
33,518
304,081
31,069
3,657,696
36.1
62,381
0.6
N/A
168,282
11,977
6,650
1,637,006
16.1
Loans held-for-sale
1,145,264
11.3
10,140,777
100.0
6,538
23,767
30,305
3,356,342
7,392
111,466
3,549,546
2,987,296
33,410
282,366
31,039
3,334,111
33.9
63,094
193,847
11,976
6,195
1,668,797
17.0
8,645,853
12.1
Represents loans individually evaluated for impairment in accordance with ASC 310-10.
First priority infrastructure loans were not risk rated as the Company is in the process of developing a risk rating policy for these loans.
After completing our impairment evaluation process as of March 31, 2019, we concluded that no additional impairment charges or releases thereof were required. During the three months ended March 31, 2019, we charged-off an allowance for impaired loans of $8.3 million relating to a first mortgage loan on a grocery distribution facility located in Montgomery, Alabama that we foreclosed on in March 2019 and obtained physical possession of the underlying collateral property. As of the foreclosure date, our carrying value of the loan totaled $9.0 million ($20.9 million unpaid principal balance net of an $8.3 million allowance for impaired loan and $3.6 million of unamortized discount).
As of March 31, 2019, we had allowances for impaired loans of $29.9 million. Of this amount, $21.6 million relates to a residential conversion project located in New York City, for which our recorded investment was as follows as of March 31, 2019: (i) $149.9 million first mortgage and contiguous mezzanine loans ($118.8 million unpaid principal balance, which does not reflect $38.4 million of accrued interest and $21.6 million allowance for impaired loan) and (ii) $6.7 million unsecured promissory note ($7.1 million unpaid principal balance and no reserve for impaired loan).
Also included in the allowance for impaired loans is $8.3 million related to two subordinated mortgages on department stores located in the Greater Chicago area. Our recorded investment in these loans totaled $12.2 million ($12.0 million unpaid principal balance and $8.3 million allowance for impaired loans) as of March 31, 2019.
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We also have a first mortgage loan on a grocery distribution facility in Orlando, Florida that was leased to a single tenant who filed for bankruptcy. This lease was rejected by the bankruptcy court with the tenant vacating and ceasing debt service in 2018. Because the liquidation value of the property exceeds our recorded investment, we determined that no impairment reserve was required. Our recorded investment in the loan totaled $18.5 million ($21.9 million unpaid principal and interest balance, net of a $3.4 million unamortized discount) as of March 31, 2019. Subsequent to March 31, 2019, we foreclosed on the loan and obtained physical possession of the underlying collateral property.
We apply the cost recovery method of interest income recognition for these impaired loans. The average recorded investment in the impaired loans for the three months ended March 31, 2019 was $199.8 million.
As of March 31, 2019, we held TDRs with unfunded commitments of $4.9 million. There were no TDRs for which interest income was recognized during the three months ended March 31, 2019.
As of March 31, 2019, the department store loans discussed above were 90 days or greater past due, as were $4.2 million of residential loans and a $36.2 million infrastructure loan with a carrying value of $29.2 million, net of a $7.0 million unamortized discount. In accordance with our interest income recognition policy, these loans were placed on non-accrual status.
In accordance with our policies, we record an allowance for loan losses equal to (i) 1.5% of the aggregate carrying amount of loans rated as a “4,” plus (ii) 5% of the aggregate carrying amount of loans rated as a “5,” plus (iii) allowance for infrastructure loans held-for-sale where amortized cost is in excess of fair value, plus (iv) impaired loan reserves, if any. The following table presents the activity in our allowance for loan losses (amounts in thousands):
Allowance for loan losses at January 1
39,151
4,330
Charge-offs
(8,352)
Recoveries
Allowance for loan losses at March 31
31,562
5,868
Recorded investment in loans related to the allowance for loan loss
266,996
245,791
The activity in our loan portfolio was as follows (amounts in thousands):
Balance at January 1
7,382,641
Acquisitions/originations/additional funding
2,027,669
1,178,560
Capitalized interest (1)
22,137
16,253
Basis of loans sold (2)
(1,127,201)
(411,625)
Loan maturities/principal repayments
(630,965)
(1,225,815)
Discount accretion/premium amortization
7,526
12,052
Changes in fair value
Unrealized foreign currency translation gain
14,208
22,552
(763)
(1,538)
Loan foreclosure
(8,963)
Transfer to/from other asset classifications
47
102
Balance at March 31
10,109,215
6,980,982
(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.
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5. Investment Securities
Investment securities were comprised of the following as of March 31, 2019 and December 31, 2018 (amounts in thousands):
Carrying Value as of
RMBS, available-for-sale
204,835
209,079
RMBS, fair value option (1)
108,816
87,879
CMBS, fair value option (1)
1,143,416
1,157,508
Held-to-maturity (“HTM”) debt securities, amortized cost
643,787
644,149
Equity security, fair value
12,506
11,893
Subtotal—Investment securities
2,113,360
2,110,508
VIE eliminations (1)
(1,203,127)
(1,204,040)
Total investment securities
Certain fair value option CMBS and RMBS are eliminated in consolidation against VIE liabilities pursuant to ASC 810.
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 March 31, 2019
Purchases
26,272
13,262
(39,534)
Sales
36,906
(33,678)
Principal collections
6,360
2,034
9,837
1,206
(11,683)
Three Months Ended March 31, 2018
30,225
(30,225)
(7,948)
10,150
15,181
208,303
(14,404)
Represents RMBS and CMBS, fair value option amounts eliminated due to our consolidation of securitization VIEs. These amounts are reflected as repayment of debt of consolidated VIEs in our condensed consolidated statements of cash flows.
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RMBS, Available-for-Sale
The Company classified all of its RMBS not eliminated in consolidation as available-for-sale as of March 31, 2019 and December 31, 2018. 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 March 31, 2019 and December 31, 2018 (amounts in thousands):
Unrealized Gains or (Losses)
Recognized in AOCI
Purchase
Recorded
Gross
Net
Amortized
Credit
Non-Credit
Unrealized
Fair Value
Cost
OTTI
Gains
Losses
Adjustment
RMBS
161,604
(9,897)
151,707
(35)
53,163
53,128
165,461
155,564
(31)
53,546
53,515
Weighted Average Coupon (1)
Weighted Average Rating
WAL (Years) (2)
CCC-
6.1
6.0
Calculated using the March 31, 2019 and December 31, 2018 one-month LIBOR rate of 2.495% and 2.503%, respectively, for floating rate securities.
Represents the remaining WAL of each respective group of securities as of the respective balance sheet date. The WAL of each individual security is calculated using projected amounts and projected timing of future principal payments.
As of March 31, 2019, approximately $174.3 million, or 85.1%, of RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.22%. As of December 31, 2018, approximately $177.4 million, or 84.9%, of RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 1.22%. We purchased all of the RMBS at a discount, a portion of which will be 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.
The following table contains a reconciliation of aggregate principal balance to amortized cost for our RMBS as of March 31, 2019 and December 31, 2018 (amounts in thousands):
Principal balance
302,229
309,497
Accretable yield
(57,391)
(54,779)
Non-accretable difference
(93,131)
(99,154)
Total discount
(150,522)
(153,933)
Amortized cost
The principal balance of credit deteriorated RMBS was $284.3 million and $290.8 million as of March 31, 2019 and December 31, 2018, respectively. Accretable yield related to these securities totaled $52.4 million and $49.5 million as of March 31, 2019 and December 31, 2018, respectively.
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The following table discloses the changes to accretable yield and non-accretable difference for our RMBS during the three months ended March 31, 2019 (amounts in thousands):
Non-Accretable
Accretable Yield
Difference
Balance as of January 1, 2019
54,779
99,154
Accretion of discount
(2,503)
Principal write-downs, net
(908)
Transfer to/from non-accretable difference
5,115
(5,115)
Balance as of March 31, 2019
57,391
93,131
We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $0.4 million and $0.5 million for the three months ended March 31, 2019 and 2018, respectively, which has been 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 March 31, 2019 and December 31, 2018, and for which other-than-temporary impairments (“OTTI”) (full or partial) have not been recognized in earnings (amounts in thousands):
Estimated Fair Value
Unrealized Losses
Securities with a
loss less than
loss greater than
12 months
2,133
As of December 31, 2018
2,148
As of both March 31, 2019 and December 31, 2018, there was one security with an unrealized loss reflected in the table above. After evaluating this security and recording adjustments for credit-related OTTI, we concluded that the remaining unrealized loss reflected above was noncredit-related and would be recovered from the security’s estimated future cash flows. We considered a number of factors in reaching this conclusion, including that we did not intend to sell the security, it was not considered more likely than not that we would be forced to sell the security 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, which represent most of the OTTI we record on securities, 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 the last date previously revised, to (ii) our amortized cost basis. Significant judgment is used in projecting cash flows for our non-agency RMBS. As a result, actual income and/or impairments could be materially different from what is currently projected and/or reported.
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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 March 31, 2019, 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 $1.1 billion and $3.0 billion, respectively. As of March 31, 2019, 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 $108.8 million and $72.3 million, respectively. The $1.3 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 $49.1 million at March 31, 2019) is eliminated against VIE liabilities before arriving at our GAAP balance for fair value option investment securities.
As of March 31, 2019, $150.7 million of our CMBS were variable rate and none of our RMBS were variable rate.
HTM Debt Securities, Amortized Cost
The table below summarizes unrealized gains and losses of our investments in HTM debt securities as of March 31, 2019 and December 31, 2018 (amounts in thousands):
Net Carrying Amount
Gross Unrealized
(Amortized Cost)
Holding Gains
Holding Losses
CMBS
409,176
1,848
(2,470)
408,554
Preferred interests
175,001
756
175,757
Infrastructure bonds
59,610
88
(545)
59,153
2,692
(3,015)
643,464
408,556
2,435
(3,349)
407,642
174,825
703
175,528
60,768
178
(168)
60,778
3,316
(3,517)
643,948
The table below summarizes the maturities of our HTM debt securities by type as of March 31, 2019 (amounts in thousands):
Preferred
Bonds
Less than one year
75,158
One to three years
305,885
12,769
318,654
Three to five years
28,133
203,134
Thereafter
46,841
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 $12.5 million and $11.9 million as of March 31, 2019 and December 31, 2018, respectively. As of March 31, 2019, our shares represent an approximate 2% interest in SEREF.
6. Properties
Our properties are held within the following portfolios:
Ireland Portfolio
The Ireland Portfolio is comprised of 11 net leased fully occupied office properties and one multifamily property all located in Dublin, Ireland, which we acquired during the year ended December 31, 2015. The Ireland Portfolio, which collectively is comprised of approximately 600,000 square feet, includes total gross properties and lease intangibles of $512.0 million and debt of $353.3 million as of March 31, 2019.
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 $624.4 million and federal, state and county sponsored financing and other debt of $406.8 million as of March 31, 2019.
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. During the year ended December 31, 2017, we acquired eight of the 27 affordable housing communities of the Woodstar II Portfolio 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 $599.4 million and debt of $437.5 million as of March 31, 2019.
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 $760.4 million and debt of $486.8 million as of March 31, 2019.
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 $192.2 million as of March 31, 2019.
Investing and Servicing Segment Property Portfolio
The Investing and Servicing Segment Property Portfolio (the “REIS Equity Portfolio”) is comprised of 19 commercial real estate properties and one equity interest in an unconsolidated commercial real estate property. During the year ended December 31, 2018, we acquired three commercial real estate properties from CMBS trusts and the remaining 16 properties were acquired from CMBS trusts prior to December 31, 2017. The REIS Equity Portfolio includes total gross properties and lease intangibles of $352.2 million and debt of $235.5 million as of March 31, 2019.
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The table below summarizes our properties held as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Depreciable Life
Property Segment
Land and land improvements
0 – 15 years
645,349
648,972
Buildings and building improvements
5 – 45 years
1,980,283
Furniture & fixtures
3 – 7 years
47,218
46,048
Investing and Servicing Segment
82,362
82,332
3 – 40 years
217,086
213,010
2 – 5 years
2,374
2,158
Commercial and Residential Lending Segment (1)
0 – 2 years
2,508
Buildings
23 years
6,455
Properties, cost
2,979,473
2,972,803
Less: accumulated depreciation
(210,099)
(187,913)
Represents properties acquired through loan foreclosure. Refer to Note 4 for further discussion.
During the three months ended March 31, 2018, we sold five operating properties for $52.3 million, recognizing a gain on sale of $10.3 million within gain on sale of investments and other assets in our condensed consolidated statement of operations. One of these properties was acquired by a third party which already held a $0.3 million non-controlling interest in the property. During the three months ended March 31, 2018, $1.3 million of the gain on sale was attributable to non-controlling interests. No operating properties were sold during the three months ended March 31, 2019.
Future rental payments due to us from tenants under existing non-cancellable operating leases for each of the next five years and thereafter are as follows (in thousands):
2019 (remainder of)
169,273
2020
131,736
2021
121,826
2022
114,467
2023
98,211
837,401
1,472,914
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7. Investment in Unconsolidated Entities
The table below summarizes our investments in unconsolidated entities as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Participation /
Carrying value as of
Ownership % (1)
Equity method:
Retail Fund
33%
70,557
114,362
Investor entity which owns equity in an online real estate company
50%
9,380
9,372
Equity interests in commercial real estate
2,654
6,294
Equity interest in and advances to a residential mortgage originator (2)
8,817
9,082
Various
25% - 50%
6,799
6,984
98,207
146,094
Cost method:
Equity interest in a servicing and advisory business
6%
6,207
Investment funds which own equity in a loan servicer and other real estate assets
4% - 6%
9,225
0% - 3%
10,721
10,239
26,153
25,671
None of these investments are publicly traded and therefore quoted market prices are not available.
Includes a $2.0 million subordinated loan the Company funded in June 2018.
We own a 33% equity interest in a fund that owns four regional shopping malls (the “Retail Fund”), an investment company that 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. During the period included in our three months ended March 31, 2019, the Retail Fund reported unrealized decreases in the fair value of its real estate properties, which resulted in a $44.9 million decrease to our investment. This amount was recognized within loss from unconsolidated entities in our condensed consolidated statement of operations during the three months ended March 31, 2019.
As of March 31, 2019, 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 March 31, 2019.
During the three months ended March 31, 2019, we did not become aware of any observable price changes in our cost method investments or any indicators of impairment.
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8. Goodwill and Intangibles
Infrastructure Lending Segment
The Infrastructure Lending Segment’s goodwill of $119.4 million at both March 31, 2019 and December 31, 2018 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 March 31, 2019 and December 31, 2018 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. At March 31, 2019 and December 31, 2018 the balance of the domestic servicing intangible was net of $24.3 million and $24.1 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 March 31, 2019 and December 31, 2018, the domestic servicing intangible had a balance of $44.1 million and $44.6 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 March 31, 2019 and December 31, 2018 (amounts in thousands):
Gross Carrying
Net Carrying
Amortization
Domestic servicing rights, at fair value
19,790
20,557
In-place lease intangible assets
197,017
(106,076)
90,941
198,220
(100,873)
97,347
Favorable lease intangible assets
36,632
(10,528)
26,104
36,895
(9,766)
27,129
Total net intangible assets
253,439
(116,604)
255,672
(110,639)
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The following table summarizes the activity within intangible assets for the three months ended March 31, 2019 (amounts in thousands):
Domestic
In-place Lease
Favorable Lease
Servicing
Intangible
Rights
Assets
(5,736)
(875)
(6,611)
Foreign exchange loss
(550)
(150)
(700)
Impairment (1)
(120)
Changes in fair value due to changes in inputs and assumptions
Impairment of intangible lease assets is recognized within other expense in our condensed consolidated statements of operations.
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):
16,406
17,390
14,950
12,158
8,946
47,195
117,045
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9. Secured Financing Agreements
The following table is a summary of our secured financing agreements in place as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Carrying Value at
Current
Extended
Pledged Asset
Maximum
December 31,
Maturity
Maturity (a)
Pricing
Carrying Value
Facility Size
Lender 1 Repo 1
(b)
LIBOR + 1.60% to 5.75%
1,723,488
2,000,000
Lender 2 Repo 1
Apr 2020
Apr 2023
LIBOR + 1.50% to 2.50%
645,636
900,000
(c)
467,390
384,791
Lender 4 Repo 2
May 2021
May 2023
LIBOR + 1.70% to 3.25%
1,073,533
1,000,000
664,637
552,345
Lender 6 Repo 1
Aug 2021
451,409
600,000
361,291
507,545
Lender 6 Repo 2
Jan 2024
GBP LIBOR + 2.45% to 2.75%, EURIBOR + 2.25%
714,538
559,524
545,880
312,437
Lender 7 Repo 1
Sep 2021
Sep 2023
LIBOR + 1.50% to 2.25%
123,071
250,000
99,064
71,720
Lender 10 Repo 1
LIBOR + 1.50% to 2.75%
200,455
164,840
160,480
Lender 11 Repo 1
Feb 2021
LIBOR + 2.10%
400,000
Lender 11 Repo 2
Sep 2019
LIBOR + 2.00% to 2.50%
354,912
500,000
220,690
270,690
Lender 12 Repo 1
Jun 2021
Jun 2024
LIBOR + 2.10% to 2.45%
233,971
176,250
43,500
Lender 13 Repo 1
(d)
LIBOR + 1.50%
137,420
200,000
106,124
14,824
Lender 7 Secured Financing
Feb 2023
LIBOR + 2.25%
(e)
650,000
(f)
Lender 8 Secured Financing
Aug 2019
LIBOR + 4.00%
Conduit Repo 2
Nov 2019
Nov 2020
116,967
91,280
35,034
Conduit Repo 3
Feb 2020
26,158
150,000
18,884
MBS Repo 1
(g)
MBS Repo 2
Dec 2020
LIBOR + 1.55% to 1.75%
222,303
159,202
MBS Repo 3
(h)
LIBOR + 1.30% to 1.85%
714,884
428,414
427,942
MBS Repo 4
(i)
LIBOR + 1.25%
151,613
100,000
60,000
13,824
MBS Repo 5
Dec 2028
Jun 2029
4.22%
57,618
55,389
55,437
Investing and Servicing Segment Property Mortgages
May 2020 to Jun 2026
264,146
242,499
223,465
219,237
Ireland Mortgage
Oct 2025
1.93%
448,324
354,875
362,854
Woodstar I Mortgages
Nov 2025 to Oct 2026
3.72% to 3.97%
343,540
276,748
Woodstar I Government Financing
Mar 2026 to Jun 2049
1.00% to 5.00%
197,385
130,607
131,179
Woodstar II Mortgages
Jan 2028 to Apr 2028
3.81% to 3.85%
526,736
417,669
Woodstar II Government Financing
Jun 2030 to Aug 2052
1.00% to 3.19%
38,680
25,229
25,311
Medical Office Mortgages
Dec 2021
Dec 2023
LIBOR + 2.50%
672,442
524,499
492,828
Master Lease Mortgages
Oct 2027
4.38%
330,998
194,900
Infrastructure Acquisition Facility
Sep 2022
(j)
1,455,572
1,528,327
1,175,677
1,551,148
Infrastructure Repo
LIBOR + 1.75%
307,636
257,318
Term Loan A
931,519
300,000
Revolving Secured Financing
FHLB
676,836
13,141,790
Unamortized net discount
(911)
(963)
Unamortized deferred financing costs
(69,784)
(77,096)
(a)
Subject to certain conditions as defined in the respective facility agreement.
Maturity date for borrowings collateralized by loans is September 2019 with an additional extension option to September 2021. Borrowings collateralized by loans existing at maturity may remain outstanding until such loan collateral matures, subject to certain specified conditions and not to exceed September 2025.
The initial maximum facility size of $600.0 million may be increased to $900.0 million at our options, subject to certain conditions.
Maturity date for borrowings collateralized by loans is May 2020 with an additional extension option to August 2021. Borrowings collateralized by loans existing at maturity may remain outstanding until such loan collateral matures, subject to certain specified conditions.
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Subject to borrower’s option to choose alternative benchmark based rates pursuant to the terms of the credit agreement.
The initial maximum facility size of $300.0 million may be increased to $650.0 million, subject to certain conditions.
Facility carries a rolling 11-month term which may reset monthly with the lender’s consent. This facility carries no maximum facility size.
Facility carries a rolling 12-month term which may reset monthly with the lender’s consent. Current maturity is March 2020. This facility carries no maximum facility size. Amounts reflect the outstanding balance as of March 31, 2019.
The date that is 270 days after the buyer delivers notice to seller, subject to a maximum date of May 2020.
Consists of an annual interest rate of the applicable currency benchmark index + 1.50%. The spread increases 25 bps in each of the second and third years of the facility which was entered into in September 2018.
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 2019, we amended the Lender 6 Repo 2 facility to increase available borrowings from £330.9 million to £429.2 million to finance a loan held-for-investment. In connection therewith, the current maturity was extended from October 2022 to January 2024.
In February 2019, we amended the Lender 11 Repo 1 facility to increase available borrowings from $200.0 million to $400.0 million to finance residential loans held-for-sale. In connection therewith, the current maturity was extended from June 2019 to February 2021.
In February 2019, we amended the MBS Repo 4 facility to decrease available borrowings from $110.0 million to $100.0 million and decrease pricing from LIBOR + 1.70% to LIBOR + 1.25%.
In February 2019, we entered into a $500.0 million repurchase facility (“Infrastructure Repo”) to finance loans within the Infrastructure Lending Segment. The facility carries a one-year initial term with a one-year extension option and an annual interest rate of LIBOR + 1.75%.
In March 2019, we amended the FHLB facility to increase available borrowings from $500.0 million to $2.0 billion, subject to scheduled reductions to available capacity from September 2020 through maturity in February 2021.
Our secured financing agreements contain certain financial tests and covenants. As of March 31, 2019, we were in compliance with all such covenants.
The following table sets forth our five‑year principal repayments schedule for secured financings assuming no defaults and excluding loans transferred as secured borrowings. 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 amount reflected in each period includes principal repayments on our credit facilities that would be required if (i) we received the repayments that we expect to receive on the investments that have been pledged as collateral under the credit facilities, as applicable, and (ii) the credit facilities that are expected to have amounts outstanding at their current maturity dates are extended where extension options are available to us (amounts in thousands):
Repurchase
Other Secured
Agreements
Financing
210,054
205,791
415,845
970,169
540,453
1,510,622
982,706
864,893
1,847,599
817,007
800,876
1,617,883
1,706,392
565,357
2,271,749
527,279
1,114,628
1,641,907
5,213,607
4,091,998
9,305,605
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For the three months ended March 31, 2019 and 2018, approximately $8.7 million and $5.1 million, respectively, of amortization of deferred financing costs from secured financing agreements was included in interest expense on our condensed consolidated statements of operations.
The following table sets forth our outstanding balance of repurchase agreements related to the following asset collateral classes as of March 31, 2019 and December 31, 2018 (amounts in thousands):
Class of Collateral
Loans held-for-investment
4,400,438
3,567,786
110,164
65,559
Investment securities
703,005
656,405
4,289,750
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 73% 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 repurchase agreements containing margin call provisions for general capital markets activity, approximately 26% 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 agreements.
10. Unsecured Senior Notes
The following table is a summary of our unsecured senior notes outstanding as of March 31, 2019 and December 31, 2018 (dollars in thousands):
Remaining
Effective
Period of
Rate
Rate (1)
Date
2019 Convertible Notes
77,969
2021 Senior Notes (February)
3.63
3.89
2/1/2021
years
2021 Senior Notes (December)
5.00
5.32
12/15/2021
700,000
2023 Convertible Notes
4.38
4.86
4/1/2023
2025 Senior Notes
4.75
5.04
3/15/2025
Total principal amount
1,950,000
2,027,969
Unamortized discount—Convertible Notes
(4,367)
(4,644)
Unamortized discount—Senior Notes
(15,365)
(16,416)
(7,473)
(8,078)
Carrying amount of debt components
Carrying amount of conversion option equity components recorded in additional paid-in capital for outstanding convertible notes
3,775
3,755
Effective rate includes the effects of underwriter purchase discount and the adjustment for the conversion option on our convertible senior notes, the value of which reduced the initial liability and was recorded in additional paid‑in capital.
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Convertible Senior Notes
During the three months ended March 31, 2019, we settled the remaining $78.0 million principal amount of the 4.00% Convertible Senior Notes due 2019 (the “2019 Notes”) through the issuance of 3.6 million shares of common stock and cash payments of $12.0 million.
We recognized interest expense of $3.2 million and $11.3 million during the three months ended March 31, 2019 and 2018, respectively, from our unsecured convertible senior notes.
The following table details the conversion attributes of our Convertible Notes outstanding as of March 31, 2019 (amounts in thousands, except rates):
Conversion Spread Value - Shares (3)
Conversion
For the Three Months Ended March 31,
Price (2)
2019 Notes
1,209
2023 Notes
38.5959
25.91
The conversion rate represents the number of shares of common stock issuable per $1,000 principal amount of Convertible Notes converted, as adjusted in accordance with the indentures governing the Convertible Notes (including the applicable supplemental indentures).
As of March 31, 2019 and 2018, the market price of the Company’s common stock was $22.35 and $20.95 per share, respectively.
The conversion spread value represents the portion of the Convertible Notes that are “in-the-money”, representing the value that would be delivered to investors in shares upon an assumed conversion.
The if‑converted value of the 2023 Notes was less than their principal amount by $34.3 million at March 31, 2019 as the closing market price of the Company’s common stock of $22.35 was less than the implicit conversion price of $25.91 per share.
Effective June 30, 2018, the Company no longer asserts its intent to fully settle the principal amount of the Convertible Notes in cash upon conversion. The if-converted value of the principal amount of the 2023 Notes was $215.7 million as of March 31, 2019.
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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.
Conduit 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. In certain instances, we retain an interest in the VIE and/or serve as special servicer for the VIE. In these circumstances, we generally consolidate the VIE into which the loans were sold. The following summarizes the fair value and par value of loans sold from our conduit platform, as well as the amount of sale proceeds used in part to repay the outstanding balance of the repurchase agreements associated with these loans for the three months ended March 31, 2019 and 2018 (amounts in thousands):
Repayment of
repurchase
Face Amount
Proceeds
agreements
179,411
186,841
136,133
256,818
193,844
Securitization Financing Arrangements and Sales
Within the Commercial and Residential Lending Segment, we originate or acquire residential and 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. These loans may be sold directly or through a securitization. In certain instances, we retain an interest in the VIE and continue to act as servicer, special servicer or servicing administrator for the loan following its sale. In these circumstances, similar to the case of our Investing and Servicing Segment described above, we generally consolidate the VIE into which the loans were sold. During the three months ended March 31, 2019, we consolidated the securitization VIE into which our residential loans were sold. In this instance, we retained an interest in the VIE. The following table summarizes our loans sold and loans transferred as secured borrowings by the Commercial and Residential Lending Segment net of expenses (amounts in thousands):
Loan Transfers
Loan Transfers Accounted for as Sales
Accounted for as Secured
Commercial
Residential
398,741
396,310
362,418
374,861
146,400
During the three months ended March 31, 2019, a gain of $0.3 million was recognized within change in fair value of mortgage loans held-for-sale, net in our condensed consolidated statement of operations in connection with the residential mortgage loan securitization. During the three months ended March 31, 2019 and 2018, gains recognized by the Commercial and Residential Lending Segment on sales of commercial loans were $2.8 million and $0.3 million, respectively.
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.
Infrastructure Loan Sales
During the three months ended March 31, 2019, the Infrastructure Lending Segment sold loans held-for-sale with an aggregate face amount of $180.3 million for proceeds of $172.7 million, recognizing gain on sales of $0.8 million.
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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 March 31, 2019 and December 31, 2018, the Company did not have any designated hedges. As of March 31, 2018, the Company had two interest rate swaps that had been designated as cash flow hedges of the interest rate risk associated with forecasted interest payments. During the three months ended March 31, 2018, the impact of these cash flow hedges on our net income was not material and we did not recognize any hedge ineffectiveness in earnings.
Non-designated Hedges and Derivatives
We have entered into the following types of non-designated hedges and derivatives:
Foreign exchange (“Fx”) forwards whereby we agree to buy or sell a specified amount of foreign currency for a specified amount of USD at a future date, economically fixing the USD amounts of foreign denominated cash flows we expect to receive or pay related to certain foreign denominated loan investments and properties;
Interest rate contracts which hedge a portion of our exposure to changes in interest rates;
Credit index instruments which hedge a portion of our exposure to the credit risk of our commercial loans held-for-sale;
Interest rate swap guarantees whereby we guarantee the interest rate swap obligations of certain Infrastructure Lending borrowers. Our interest rate swap guarantees were assumed in connection with the acquisition of the Infrastructure Lending Segment.
The following table summarizes our non-designated derivatives as of March 31, 2019 (notional amounts in thousands):
Type of Derivative
Number of Contracts
Aggregate Notional Amount
Notional Currency
Fx contracts – Sell Euros ("EUR")
56
281,609
EUR
April 2019 – October 2022
Fx contracts – Sell Pounds Sterling ("GBP")
142
320,633
GBP
April 2019 – January 2022
Fx contracts – Sell Canadian dollar ("CAD")
8,597
CAD
Fx contracts – Sell Australian dollar ("AUD")
7,521
AUD
April 2019 – October 2019
Interest rate swaps – Paying fixed rates
1,132,992
USD
April 2019 – April 2029
Interest rate swaps – Receiving fixed rates
970,000
January 2021 – March 2025
Interest rate caps
109,584
January 2020 – December 2021
Credit index instruments
39,000
November 2054 – August 2061
Interest rate swap guarantees
658,493
December 2020 – June 2025
11,091
December 2024
91,374
June 2045
271
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 March 31, 2019 and December 31, 2018 (amounts in thousands):
Fair Value of Derivatives
in an Asset Position (1) as of
in a Liability Position (2) as of
Derivatives not designated as hedging instruments:
Interest rate contracts
21,412
30,791
6,973
14,457
577
396
Foreign exchange contracts
25,978
21,346
2,613
562
554
Total derivatives not designated as hedging instruments
Total derivatives
Classified as derivative assets in our condensed consolidated balance sheets.
Classified as derivative liabilities in our condensed consolidated balance sheets.
The tables below present the effect of our derivative financial instruments on the condensed consolidated statements of operations and of comprehensive income for the three months ended March 31, 2019 and 2018 (amounts in thousands):
Gain (Loss)
Reclassified
Recognized
from AOCI
Derivatives Designated as Hedging Instruments
in OCI
into Income
in Income
Location of Gain (Loss)
(effective portion)
(ineffective portion)
Recognized in Income
Amount of Gain (Loss)
Recognized in Income for the
Derivatives Not Designated
Three Months Ended March 31,
as Hedging Instruments
Loss on derivative financial instruments
(3,757)
6,237
(182)
2,444
(23,143)
(712)
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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)
Financial Position
Instruments
Pledged
Net Amount
4,449
42,961
3,285
2,429
Repurchase agreements
5,223,770
5,218,056
1,408
51,283
8,658
5,349
4,305,165
4,291,158
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.
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We also hold controlling interests in non-securitization entities that are considered VIEs, most of which were established to facilitate the acquisition of certain properties. 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 net assets of $692.4 million and liabilities of $445.0 million as of March 31, 2019. In total, our consolidated non-securitization VIEs had net assets of $799.1 million and liabilities of $531.2 million as of March 31, 2019.
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.
As of March 31, 2019, four of our collateralized debt obligation (“CDO”) structures 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 March 31, 2019, 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 March 31, 2019, our maximum risk of loss related to securitization VIEs in which we were not the primary beneficiary was $49.1 million on a fair value basis.
As of March 31, 2019, 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 $6.5 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 $88.6 million as of March 31, 2019, 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.
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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 March 31, 2019 and 2018, approximately $19.6 million and $17.5 million, respectively, was incurred for base management fees. As of March 31, 2019 and December 31, 2018, there were $19.6 million and $19.2 million, respectively, of unpaid base management fees included in related-party payable in our condensed consolidated balance sheets.
Incentive Fee. For the three months ended March 31, 2019 and 2018, approximately $0.2 million and $9.6 million, respectively, was incurred for incentive fees. As of March 31, 2019, there were no unpaid incentive fees. As of December 31, 2018, approximately $21.8 million of unpaid incentive fees were included in related-party payable in our condensed consolidated balance sheet.
Expense Reimbursement. For the three months ended March 31, 2019 and 2018, approximately $2.2 million and $2.1 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. As of March 31, 2019 and December 31, 2018, approximately $4.4 million and $3.0 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 March 31, 2019 and 2018, we granted 114,216 and 189,813 RSAs, respectively, at grant date fair values of $2.6 million and $4.0 million, respectively. Expenses related to the vesting of awards to employees of affiliates of our Manager were $0.8 million and $0.5 million during the three months ended March 31, 2019 and 2018, respectively, and are reflected in general and administrative expenses in our condensed consolidated statements of operations. 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 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 May 2015, we granted 675,000 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 $3.2 million and $2.9 million within management fees in our condensed consolidated statements of operations for the three months ended March 31, 2019 and 2018, respectively. Refer to Note 16 for further discussion of these grants.
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Investments in Loans
In February 2019, the Company acquired a $60.0 million first priority infrastructure term loan participation which bears interest at LIBOR plus 3.75%. The loan is secured by two domestic natural gas power plants. An affiliate of our Manager, Starwood Energy Group, is the loan sponsor.
In March 2019, the Company originated a $22.5 million loan to refinance the debt of a commercial real estate partnership in which we hold a 50% equity interest.
During the three months ended March 31, 2019, the Company acquired $71.9 million of loans held-for-sale from a residential mortgage originator in which it holds an equity interest. Refer to Note 7 for further discussion.
Other Related-Party Arrangements
In March 2019, we engaged Highmark Residential (“Highmark”) (formerly known as Milestone Management), an affiliate of our Manager, to provide property management services for nine additional properties within our Woodstar I Portfolio, bringing the total number of our properties managed by Highmark to 19. Fees paid to Highmark are calculated as a percentage of gross receipts and are at market terms. During the three months ended March 31, 2019, property management fees paid to Highmark were $0.3 million.
Acquisitions from Consolidated CMBS Trusts
Our Investing and Servicing Segment acquires interests in properties for its REIS Equity Portfolio from CMBS trusts, some of which are consolidated as VIEs on our balance sheet. Acquisitions from consolidated VIEs are reflected as repayment of debt of consolidated VIEs in our condensed consolidated statements of cash flows. No real estate assets were acquired from consolidated CMBS trusts during the three months ended March 31, 2019. During the three months ended March 31, 2018, we acquired $27.7 million of net real estate assets from consolidated CMBS trusts for a gross purchase price of $28.0 million.
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 three months ended March 31, 2019, our board of directors declared the following dividends:
Declaration Date
Record Date
Ex-Dividend Date
Payment Date
Frequency
2/28/19
3/29/19
3/28/19
4/15/19
0.48
Quarterly
During the three months ended March 31, 2019, we issued 3.6 million shares of common stock in connection with the settlement of $78.0 million of our 2019 Notes. Refer to Note 10 for further discussion.
During the three months ended March 31, 2019 and 2018, there were no shares issued under our At-The-Market Equity Offering Sales Agreement. During the three months ended March 31, 2019 and 2018, shares issued under the Starwood Property Trust, Inc. Dividend Reinvestment and Direct Stock Purchase Plan (the “DRIP Plan”) were not material.
In February 2017, our board of directors extended the term of our $500.0 million common stock and Convertible Note repurchase program through January 2019. Refer to Note 17 to the consolidated financial statements included in our Form 10-K for further information regarding the repurchase program. There were no share or Convertible Notes repurchases under the repurchase program during the three months ended March 31, 2019. During the three months ended March 31, 2018, we repurchased 573,255 shares of common stock for $12.1 million and no Convertible Notes under our repurchase program.
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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 three months ended March 31, 2019 and 2018 (dollar amounts in thousands):
Grant Date
Type
Amount Granted
Grant Date Fair Value
Vesting Period
April 2018
RSU
775,000
16,329
3 years
March 2017
22,240
May 2015
675,000
16,511
Schedule of Non-Vested Shares and Share Equivalents
2017
Weighted Average
Manager
Grant Date Fair
Equity Plan
Value (per share)
1,436,445
997,920
2,434,365
21.52
Granted
383,190
22.58
Vested
(402,541)
(147,916)
(550,457)
21.41
Forfeited
(4,419)
22.67
1,412,675
850,004
2,262,679
21.72
As of March 31, 2019, there were 8.8 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 11.9 million Class A Units in SPT Dolphin and have an obligation to issue an additional 0.2 million Class A Units if certain contingent events occur. 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. In consolidation, the issued Class A Units are reflected as non-controlling interests in consolidated subsidiaries on our condensed consolidated balance sheets.
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 months ended March 31, 2019 and 2018, we recognized net income attributable to non-controlling interests of $5.7 million and $2.5 million, respectively, associated with these Class A Units.
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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
(824)
(721)
Basic earnings
69,559
99,211
Diluted Earnings
Add: Interest expense on Convertible Notes (1)
*
Add: Loss on extinguishment of Convertible Notes (1)
Diluted earnings
Number of Shares:
Basic — Average shares outstanding
277,544
260,664
Effect of dilutive securities — Convertible Notes (1)
Effect of dilutive securities — Contingently issuable shares
229
Effect of dilutive securities — Unvested non-participating shares
154
Diluted — Average shares outstanding
277,698
262,124
Earnings Per Share Attributable to STWD Common Stockholders:
0.25
0.38
Prior to June 30, 2018, the Company had asserted its intent and ability to settle the principal amount of the Convertible Notes in cash. Accordingly, under GAAP, the dilutive effect to EPS for the prior year period was determined using the treasury stock method by dividing only the “conversion spread value” of the “in-the-money” Convertible Notes by the Company’s average share price and including the resulting share amount in the diluted EPS denominator. The conversion value of the principal amount of the Convertible Notes was not included. Effective June 30, 2018, the Company no longer asserts its intent to fully settle the principal amount of the Convertible Notes in cash upon conversion. Accordingly, under GAAP, the dilutive effect to EPS for the current year period is determined using the “if-converted” method whereby interest expense or any loss on extinguishment of our Convertible Notes is added back to the diluted EPS numerator and the full number of potential shares contingently issuable upon their conversion is included in the diluted EPS denominator, if dilutive. Refer to Note 10 for further discussion.
*Our Convertible Notes were not dilutive for the three months ended March 31, 2019.
As of March 31, 2019 and 2018, participating shares of 13.6 million and 11.3 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 March 31, 2019 and 2018 included 11.9 million and 9.8 million potential shares, respectively, of our common stock issuable upon redemption of the Class A Units in SPT Dolphin, as discussed in Note 16.
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18. Accumulated Other Comprehensive Income
The changes in AOCI by component are as follows (amounts in thousands):
Cumulative
Unrealized Gain
Effective Portion of
(Loss) on
Foreign
Cumulative Loss on
Available-for-
Currency
Cash Flow Hedges
Sale Securities
Translation
Balance at January 1, 2019
5,145
OCI before reclassifications
Amounts reclassified from AOCI
Net period OCI
Balance at March 31, 2019
2,670
Balance at January 1, 2018
57,889
12,010
5,436
(4)
(46)
(50)
Balance at March 31, 2018
59,052
16,228
The reclassifications out of AOCI impacted the condensed consolidated statements of operations for the three months ended March 31, 2019 and 2018 as follows (amounts in thousands):
Amounts Reclassified from
AOCI during the Three Months
Affected Line Item
Ended March 31,
in the Statements
Details about AOCI Components
of Operations
Gain (loss) on cash flow hedges:
Unrealized gains (losses) on available-for-sale securities:
Interest realized upon collection
46
Total reclassifications for the period
50
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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. Refer to Note 20 to the consolidated financial statements included in our Form 10-K for further discussion of our valuation process.
We determine the fair value of our assets and liabilities measured at fair value on a recurring and nonrecurring basis in accordance with the methodology described in our Form 10-K.
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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 March 31, 2019 and December 31, 2018 (amounts in thousands):
Level I
Level II
Level III
Financial Assets:
Loans held-for-sale, fair value option
841,687
49,105
10,770
38,335
Equity security
Domestic servicing rights
VIE assets
58,180
58,079,511
Financial Liabilities:
VIE liabilities
2,046,559
671,282
41,347
16,119
25,228
54,453,213
68,810
54,372,510
50,753,596
1,441,446
52,210,457
50,769,011
The changes in financial assets and liabilities classified as Level III are as follows for the three months ended March 31, 2019 and 2018 (amounts in thousands):
VIE
Held‑for‑sale
VIE Assets
Liabilities
January 1, 2019 balance
(1,441,446)
52,931,064
Total realized and unrealized gains (losses):
Included in earnings:
Change in fair value / gain on sale
(295)
294,345
33,957
338,506
Net accretion
2,503
Included in OCI
Purchases / Originations
740,296
(561,702)
(3,228)
(564,930)
Issuances
Cash repayments / receipts
(19,455)
(6,360)
(188)
(389)
(26,392)
Transfers into Level III
5,350
(670,742)
(665,392)
Transfers out of Level III
136,592
Consolidation of VIEs
(103,309)
3,176,756
Deconsolidation of VIEs
11,468
(45,910)
32,456
(1,986)
March 31, 2019 balance
(2,046,559)
56,032,952
Amount of total gains (losses) included in earnings attributable to assets still held at March 31, 2019
3,169
(567)
332,640
January 1, 2018 balance
745,743
247,021
24,191
30,759
51,045,874
(2,188,937)
49,904,651
555
(2,027,208)
237,090
(1,787,577)
2,819
277,259
(266,632)
(40,437)
(10,150)
(777)
(12,633)
(63,997)
(530,888)
208,258
(875,240)
89,324
(785,916)
March 31, 2018 balance
723,733
240,853
23,969
24,945
49,233,307
(2,205,734)
48,041,073
Amount of total (losses) gains included in earnings attributable to assets still held at March 31, 2018
(640)
2,772
(1,793,245)
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:
Loans held-for-investment, loans held-for-sale and loans transferred as secured borrowings
9,267,528
9,315,914
9,122,972
9,178,709
HTM debt securities
Financial liabilities not carried at fair value:
Secured financing agreements and secured borrowings on transferred loans
9,139,056
8,757,804
8,662,548
Unsecured senior notes
1,962,208
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 as of (1)
Technique
Input
Discounted cash flow
Yield (b)
4.2% - 6.0%
4.6% - 6.1%
Duration (c)
2.4 - 13.6 years
2.5 - 14.4 years
Constant prepayment rate (a)
2.0% - 22.2%
3.2% - 25.2%
Constant default rate (b)
1.0% - 4.6%
1.1% - 5.5%
Loss severity (b)
0% - 76% (e)
0% - 73% (e)
Delinquency rate (c)
6% - 31%
4% - 31%
Servicer advances (a)
21% - 85%
21% - 83%
Annual coupon deterioration (b)
0% - 1.8%
0% - 1.4%
Putback amount per projected total collateral loss (d)
0% - 7%
0% - 166.3%
0% - 473.5%
0 - 9.7 years
Debt yield (a)
7.75%
Discount rate (b)
15%
Control migration (b)
0% - 80%
0% - 401.4%
0% - 290.9%
0 - 13.4 years
0 - 20.4 years
0 - 13.7 years
The ranges of significant unobservable inputs are represented in percentages and years.
Sensitivity of the Fair Value to Changes in the Unobservable Inputs
Significant increase (decrease) in the unobservable input in isolation would result in a significantly higher (lower) fair value measurement.
Significant increase (decrease) in the unobservable input in isolation would result in a significantly lower (higher) fair value measurement.
Significant increase (decrease) in the unobservable input in isolation would result in either a significantly lower or higher (higher or lower) fair value measurement depending on the structural features of the security in question.
Any delay in the putback recovery date leads to a decrease in fair value for the majority of securities in our RMBS portfolio.
41% and 55% of the portfolio falls within a range of 45%-80% as of March 31, 2019 and December 31, 2018, respectively.
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 March 31, 2019 and December 31, 2018, approximately $980.5 million and $553.5 million, 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.
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The following table is a reconciliation of our U.S. federal income tax determined using our statutory federal tax rate to our reported income tax provision for the three months ended March 31, 2019 and 2018 (dollars in thousands):
Federal statutory tax rate
16,137
21.0
22,606
REIT and other non-taxable income
(16,160)
(21.0)
(20,343)
(18.9)
State income taxes
(6)
593
Federal benefit of state tax deduction
(124)
(0.1)
362
0.4
124
0.1
Effective tax rate
334
2,856
2.7
21. Commitments and Contingencies
As of March 31, 2019, our Commercial and Residential Lending Segment had future commercial loan funding commitments totaling $1.9 billion, of which we expect to fund $1.7 billion. These future funding commitments primarily relate to construction projects, capital improvements, tenant improvements and leasing commissions. Additionally, as of March 31, 2019, our Commercial and Residential Lending Segment had no outstanding residential mortgage loan purchase commitments under an agreement to purchase up to $600.0 million of residential mortgage loans that meet our investment criteria from a third party residential mortgage originator.
As of March 31, 2019, our Infrastructure Lending Segment had future infrastructure loan funding commitments totaling $341.8 million, including $221.0 million under revolvers and letters of credit (“LCs”), and $120.8 million under delayed draw term loans. As of March 31, 2019, $20.9 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 March 31, 2019, we had 11 outstanding guarantees on interest rate swaps maturing between December 2020 and June 2045. 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.
49
Lease Commitment Disclosures
Our lease commitments consist of corporate office leases and ground leases for investment properties, all of which are classified as operating leases. We sublease some of the space within our corporate offices to third parties. Our lease costs and sublease income were as follows (in thousands):
Operating lease costs
1,238
1,253
Short-term lease costs
Sublease income
(399)
(439)
Total lease cost
863
844
Information concerning our operating lease liabilities, which are classified within accounts payable, accrued expenses and other liabilities in our condensed consolidated balance sheet as of March 31, 2019, is as follows (dollars in thousands):
Cash paid for amounts included in the measurement of lease liabilities—operating
1,291
Weighted-average remaining lease term
2.25
Weighted-average discount rate
5.0
Future maturity of operating lease liabilities:
3,924
5,292
2,216
11,432
Less interest component
(621)
Operating lease liability
10,811
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 March 31, 2019 by business segment (amounts in thousands):
Commercial and
Investing
Lending
and Servicing
Segment
Corporate
Subtotal
VIEs
154,595
26,915
1,906
19,908
885
24,293
45,086
(27,454)
123
27,243
27,366
(2,933)
70,521
13,312
204
686
78
196
1,184
(18)
174,830
28,486
70,599
66,950
340,885
(30,405)
411
22,988
23,417
61,604
18,577
18,990
7,746
27,915
134,832
(160)
6,768
4,479
1,518
18,851
3,226
34,842
249
77
22,937
6,695
71
23,896
5,287
(11)
774
134
69,188
23,846
67,475
38,674
54,129
253,312
(23)
(515)
(252)
(1,694)
18,140
16,446
(16,384)
1,386
9,880
Earnings (loss) from unconsolidated entities
(43,805)
594
(42,634)
(566)
2,755
790
940
(Loss) gain on derivative financial instruments, net
(9,297)
(395)
1,290
(3,432)
9,627
Foreign currency gain (loss), net
5,239
300
(Loss) gain on extinguishment of debt
(3,304)
Other loss, net
Total other income (loss)
(1,034)
(2,609)
(42,506)
25,606
9,560
(10,983)
30,634
Income (loss) before income taxes
104,608
2,031
(39,382)
53,882
(44,549)
76,590
252
Income tax benefit (provision)
248
85
(258)
(409)
Net income (loss)
104,856
2,116
(39,640)
53,473
76,256
Net (income) loss attributable to non-controlling interests
(371)
(5,717)
215
(5,873)
Net income (loss) attributable to Starwood Property Trust, Inc.
104,485
(45,357)
53,688
51
The table below presents our results of operations for the three months ended March 31, 2018 by business segment (amounts in thousands):
134,972
2,648
14,439
34,399
48,838
(33,569)
165
33,434
33,599
(7,532)
66,710
14,400
194
101
228
52
575
(54)
149,770
66,811
85,109
301,742
(41,155)
480
30,051
30,549
93
32,021
16,534
5,095
33,803
87,453
(270)
1,859
21,020
2,482
32,056
86
220
151
23,488
6,205
26,469
5,258
41,048
68,356
37,774
66,336
213,514
(91)
(9,168)
3,354
(704)
13,979
13,275
(13,424)
(1,692)
9,492
1,444
(3,515)
1,596
(475)
(987)
279
3,942
6,439
(10,818)
1,919
5,042
(13,002)
13,550
Other income, net
2,102
2,365
27,425
18,890
41,596
110,824
820
74,760
(79,286)
107,118
532
(947)
(1,261)
(648)
109,877
(441)
74,112
104,262
(361)
(2,453)
(1,516)
(4,330)
(532)
109,516
(2,894)
72,596
The table below presents our condensed consolidated balance sheet as of March 31, 2019 by business segment (amounts in thousands):
13,206
58
36,107
47,225
295,463
392,059
20,211
32,156
68,057
19,671
13,295
535
7,513,130
1,498
302,803
1,061,011
992,739
8,937
2,487,285
273,152
Intangible assets
85,356
75,806
161,162
(24,327)
35,351
54,251
160,159
(35,799)
119,409
140,437
14,247
1,029
32,093
50,269
7,135
392
296
3,079
61,171
(857)
11,259
72,720
65,898
75,348
1,944
227,169
(16)
VIE assets, at fair value
9,428,001
2,080,918
2,797,359
1,827,340
301,021
16,434,639
55,730,949
29,302
6,788
63,644
71,675
21,628
193,037
106
23,935
4,608
772
2,739
2,044
5,010,958
1,410,124
1,876,514
653,078
298,186
9,248,860
(13,950)
5,044,869
1,417,684
1,940,158
727,501
2,404,477
11,534,689
55,713,932
1,199,646
663,692
631,392
118,760
2,466,683
Treasury stock
Accumulated other comprehensive income (loss)
2,734
(64)
Retained earnings (accumulated deficit)
3,120,166
(458)
(31,787)
967,326
(4,468,800)
4,372,940
663,234
602,339
1,086,022
(2,103,456)
10,192
254,862
13,817
278,871
17,017
4,383,132
857,201
1,099,839
4,899,950
53
The table below presents our condensed consolidated balance sheet as of December 31, 2018 by business segment (amounts in thousands):
14,385
27,408
31,449
164,015
237,270
2,554
28,324
175,659
25,144
11,679
7,235
7,072,220
3,357
670,155
47,622
1,050,920
998,820
2,512,847
272,043
90,889
78,219
169,108
(24,075)
35,274
44,129
193,765
(22,000)
18,174
1,066
32,733
718
39,862
6,982
359
616
13,177
60,996
(641)
13,958
20,472
67,098
49,363
2,057
152,948
(26)
9,017,618
2,310,923
2,870,840
1,678,452
186,484
16,064,317
52,198,136
26,508
26,476
67,415
75,655
21,467
217,521
43,990
477
1,423
12,188
4,405,599
1,524,551
1,884,187
585,258
297,920
8,697,515
Secured borrowings on transferred loans
4,507,636
1,551,504
1,951,639
662,389
2,507,862
11,181,030
52,181,234
1,430,503
761,992
645,561
87,779
2,069,321
53,516
5,208
3,015,676
(2,573)
13,570
913,642
(4,289,313)
4,499,695
759,419
664,339
1,001,357
(2,321,378)
10,287
14,706
279,855
16,902
4,509,982
919,201
1,016,063
4,883,287
54
23. Subsequent Events
Our significant events subsequent to March 31, 2019 were as follows:
Dividend Declaration
On May 8, 2019, our board of directors declared a dividend of $0.48 per share for the second quarter of 2019, which is payable on July 15, 2019 to common stockholders of record as of June 28, 2019.
55
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, 2018 (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.
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.
Developments During the First Quarter of 2019
The Commercial and Residential Lending Segment originated $1.0 billion of commercial loans during the quarter, including the following:
o
$379.0 million first mortgage and mezzanine loan for the acquisition and redevelopment of two office buildings located in Manhattan, New York, of which the Company funded $236.0 million.
₤249.9 million first mortgage loan to the owner of the United Kingdom’s market leading convention and exhibition center business. The loan is secured by five large conference facilities totaling over two million square feet and was fully funded.
$145.0 million first mortgage and mezzanine loan for the acquisition of a newly constructed, full-service hotel located in New York, New York, which the Company fully funded.
$97.2 million first mortgage and mezzanine loan for the refinancing of three Class A office buildings located in Herndon, Virginia, of which the Company funded $73.3 million.
Funded $218.9 million of previously originated commercial loan commitments.
Received gross proceeds of $655.8 million (net proceeds of $183.4 million) from sales, maturities and principal repayments on our commercial loans, of which $396.3 million related to loan sales.
Acquired $237.5 million of infrastructure loans and funded $46.3 million of existing infrastructure loan commitments.
Received proceeds of $172.7 million from sales of infrastructure loans and $285.2 million from repayments and maturities.
Received proceeds of $352.0 million, including retained RMBS of $26.3 million, from the securitization of $340.2 million of residential mortgage loans.
Originated commercial conduit loans of $282.8 million. Separately, received proceeds of $186.8 million from sales of previously originated commercial conduit loans.
Obtained four new special servicing assignments for CMBS trusts with a total unpaid principal balance of $3.2 billion.
Sold CMBS held by our Investing and Servicing Segment for total gross proceeds of $36.9 million and acquired CMBS for a purchase price of $13.3 million.
Settled the remaining $78.0 million of our 4.00% Convertible Senior Notes due 2019 (the “2019 Notes”) through the issuance of 3.6 million shares of common stock and cash payments of $12.0 million.
Subsequent Events
Refer to Note 23 to the Condensed Consolidated Financial Statements for disclosure regarding significant transactions that occurred subsequent to March 31, 2019.
57
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 months ended March 31, 2019 and 2018 by business segment (amounts in thousands):
$ Change
Commercial and Residential Lending Segment
25,060
3,788
(18,159)
(32)
Securitization VIE eliminations
10,750
49,893
28,140
(881)
900
(12,207)
68
39,866
(3,136)
(44,871)
(1,819)
22,562
(10,962)
(40,835)
Income (loss) before income taxes:
(6,216)
(40,202)
(20,878)
34,737
(280)
(30,808)
2,522
(1,263)
(29,549)
Three Months Ended March 31, 2019 Compared to the Three Months Ended March 31, 2018
Revenues
For the three months ended March 31, 2019, revenues of our Commercial and Residential Lending Segment increased $25.0 million to $174.8 million, compared to $149.8 million for the three months ended March 31, 2018. This increase was primarily due to increases in interest income from loans of $19.6 million and investment securities of $5.4 million. The increase in interest income from loans was principally due to (i) increased LIBOR rates and (ii) higher average balances of both commercial loans and residential loans held-for-sale, partially offset by (iii) lower levels of prepayment related income and (iv) the compression of interest rate spreads in credit markets. The increase in interest income from investment securities was primarily due to higher average investment balances partially offset by lower levels of prepayment related income.
Costs and Expenses
For the three months ended March 31, 2019, costs and expenses of our Commercial and Residential Lending Segment increased $28.2 million to $69.2 million, compared to $41.0 million for the three months ended March 31, 2018. This increase was primarily due to a $29.6 million increase in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio.
Net Interest Income (amounts in thousands)
Change
19,623
5,469
(61,604)
(32,021)
(29,583)
Net interest income
112,899
117,390
(4,491)
For the three months ended March 31, 2019, net interest income of our Commercial and Residential Lending Segment decreased $4.5 million to $112.9 million, compared to $117.4 million for the three months ended March 31, 2018. This decrease reflects the net increase in interest income explained in the Revenues discussion above, which was more than offset by the increase in interest expense on our secured financing facilities primarily due to increased utilization of our available borrowing capacity and lower prepayment related income.
During the three months ended March 31, 2019 and 2018, the weighted average unlevered yields on the Commercial and Residential Lending Segment’s loans and investment securities were as follows:
Overall
The overall weighted average unlevered yield was slightly lower as increases in LIBOR were more than offset by lower levels of prepayment related income and the compression of interest rate spreads in credit markets.
During the three months ended March 31, 2019 and 2018, 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 4.6% and 4.1%, respectively, and 4.6% and 4.0%, respectively, excluding the impact of bridge financing. The increases in borrowing rates primarily reflect increases in LIBOR, partially offset by the compression of interest rate spreads in credit markets.
59
Other Income (Loss)
For the three months ended March 31, 2019, other income (loss) of our Commercial and Residential Lending Segment decreased $3.1 million to a loss of $1.0 million, compared to income of $2.1 million for the three months ended March 31, 2018. The decrease was primarily due to an $8.3 million decrease in foreign currency gain, partially offset by a $3.1 million favorable change in fair value of residential mortgage loans held-for-sale and a $1.5 million lower loss on derivatives. The lower loss on derivatives reflects a $10.7 million lower loss on foreign currency hedges, partially offset by a $9.2 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 CMBS investments. The lower loss on the foreign currency hedges and the decrease in foreign currency gain reflect the overall weakening of the U.S. dollar against the pound sterling (“GBP”) in the first quarter of 2019 versus a greater weakening of the U.S. dollar in the first quarter of 2018. The interest rate swaps are used primarily to fix our interest rate payments on certain variable rate borrowings which fund fixed rate investments.
The Infrastructure Lending Segment was acquired on September 19, 2018. Accordingly, the following discussion reflects its results for the three months ended March 31, 2019 and includes no comparison to the three months ended March 31, 2018.
Revenues of our Infrastructure Lending Segment were $28.5 million, including interest income of $26.9 million from loans and $0.9 million from investment securities.
Costs and expenses of our Infrastructure Lending Segment were $23.8 million, consisting primarily of $18.6 million of interest expense on secured debt facilities used to finance this segment’s investment portfolio and $4.5 million of general and administrative expenses.
(18,577)
9,223
Interest income from infrastructure loans and investment securities and interest expense on the secured financing facilities reflect primarily variable LIBOR based rates. During the three months ended March 31, 2019, the weighted average unlevered yield on the Infrastructure Lending Segment’s loans and investment securities held-for-investment was 6.1% while the weighted average unlevered yield on its loans held-for-sale was 3.6%. The weighted average secured borrowing rate on its debt facilities, including amortization of deferred financing fees, was 5.0%.
Other Loss
Other loss of our Infrastructure Lending Segment was $2.6 million, primarily reflecting a $3.3 million 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.
60
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
(5,433)
(3,912)
(3,941)
(5,462)
(391)
(22)
(15,728)
(16,097)
(416)
15,098
15,251
785
(1,226)
2,011
9,097
4,959
(17)
4,121
(40,290)
Other/Corporate
(264)
264
(630)
(44,241)
See Note 6 to the Condensed Consolidated Financial Statements for a description of the above-referenced Property Segment portfolios.
For the three months ended March 31, 2019, revenues of our Property Segment increased $3.8 million to $70.6 million, compared to $66.8 million for the three months ended March 31, 2018. The increase in revenues in the first quarter of 2019 was primarily due to the full period inclusion of rental income from the Woodstar II Portfolio, which was acquired over a period between December 2017 and September 2018, partially offset by a decrease in rental income from the Master Lease Portfolio due to (i) no longer recording as revenues and offsetting expenses property taxes paid directly by lessees, in accordance with the new lease accounting standard effective January 1, 2019 (see Note 2 to the Consolidated Financial Statements) and (ii) the sale of seven properties within the Master Lease portfolio during 2018.
For the three months ended March 31, 2019, costs and expenses of our Property Segment decreased $0.9 million to $67.5 million, compared to $68.4 million for the three months ended March 31, 2018. The decrease in costs and expenses reflects decreases in each of the portfolios except for the Woodstar II Portfolio, which reflects an increase due to its full period inclusion. The $3.9 million decrease in costs and expenses of the Master Lease Portfolio was primarily due to the effects of no longer recording property taxes paid directly by lessees and the sale of seven properties in 2018, both as discussed above.
For the three months ended March 31, 2019, other income (loss) of our Property Segment decreased $44.9 million to a loss of $42.5 million, compared to income of $2.4 million for the three months ended March 31, 2018. The decrease in other income was primarily due to (i) a $40.3 million increased loss from an unconsolidated entity, (ii) the non-recurrence of a $3.9 million net gain on sale of two properties in the Master Lease Portfolio during the first quarter of 2018 and (iii) a $0.6 million decreased net gain on derivatives. The $40.3 million increased loss from an unconsolidated entity principally reflects the recognition of decreases in fair value of properties held by our equity investee that owns four regional shopping malls (the “Retail Fund”), which is an investment company that measures its assets at fair value (see Note 7 to the Consolidated Financial Statements). The decreased net gain on derivatives consists of a $15.7 million unfavorable change in interest rate swaps which primarily hedge the variable interest rate risk on borrowings secured by our Medical Office Portfolio, partially offset by a $15.1 million favorable change in foreign exchange contracts which economically hedge our Euro currency exposure with respect to the Ireland Portfolio.
61
For the three months ended March 31, 2019, revenues of our Investing and Servicing Segment decreased $18.2 million to $66.9 million, compared to $85.1 million for the three months ended March 31, 2018. The decrease in revenues in the first quarter of 2019 was primarily due to (i) a $10.1 million decrease in CMBS interest income principally due to lower interest recoveries, (ii) a $6.2 million decrease in servicing fees and (iii) a $1.1 million decrease in rental income on our REIS Equity Portfolio (described in Note 6 to the Condensed Consolidated Financial Statements) primarily due to sales of nine operating properties during 2018.
For the three months ended March 31, 2019, costs and expenses of our Investing and Servicing Segment increased by $0.9 million to $38.7 million, compared to $37.8 million for the three months ended March 31, 2018.
Other Income
For the three months ended March 31, 2019, other income of our Investing and Servicing Segment decreased $1.8 million to $25.6 million, from $27.4 million for the three months ended March 31, 2018. The decrease in other income was primarily due to (i) an $8.5 million unfavorable change in gain (loss) on derivatives which primarily hedge our interest rate risk on conduit loans and (ii) a $5.5 million decrease in gains on sales of operating properties, partially offset by (iii) an $8.6 million lesser decrease in fair value of servicing rights primarily reflecting the expected reduction in amortization of this deteriorating asset net of increases in fair value due to the attainment of new servicing contracts and (iv) a $4.1 million greater increase in fair value of CMBS securities.
Corporate and Other Items
Corporate Costs and Expenses
For the three months ended March 31, 2019, corporate expenses decreased $12.2 million to $54.1 million, compared to $66.3 million for the three months ended March 31, 2018. The decrease was primarily due to a $7.1 million decrease in management fees and a $5.9 million decrease in interest expense principally on lower average outstanding balances of our unsecured senior notes.
Corporate Other Income (Loss)
For the three months ended March 31, 2019, corporate other income (loss) increased $22.6 million to income of $9.6 million, compared to a loss of $13.0 million for the three months ended March 31, 2018. The increase in corporate other income was due to a favorable change in gain (loss) on interest rate swaps used to 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 for the CMBS and RMBS VIEs that we consolidate as primary beneficiary. Such eliminations have no overall effect on net income 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 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 Provision
Historically, our consolidated income tax provision principally relates to the taxable nature of the Investing and Servicing Segment’s loan servicing and loan conduit businesses which are housed in TRSs. For the three months ended March 31, 2019, we had a tax provision of $0.3 million compared to $2.8 million in the three months ended March 31, 2018. The $2.5 million decrease primarily reflects a decrease in the taxable income of our TRSs.
Net Income Attributable to Non-controlling Interests
During the three months ended March 31, 2019, net income attributable to non-controlling interests increased $1.2 million to $6.1 million, compared to $4.9 million during the three months ended March 31, 2018. The increase was primarily due to the effect of non-controlling interests in our Woodstar II Portfolio, which consists of properties acquired in and after December 2017.
63
Non-GAAP Financial Measures
Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding the following:
non-cash equity compensation expense;
incentive fees due under our management agreement;
(iii)
depreciation and amortization of real estate and associated intangibles;
acquisition costs associated with successful acquisitions;
(v)
any unrealized gains, losses or other non-cash items recorded in net income for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income; and
(vi)
any deductions for distributions payable with respect to equity securities of subsidiaries issued in exchange for properties or interests therein.
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 (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:
Unvested stock awards – Currently, unvested stock awards are excluded from the denominator of GAAP EPS. The related compensation expense is also excluded from Core Earnings. In order to effectuate dilution from these awards in the Core Earnings computation, we adjust the GAAP diluted share count to include these shares.
Convertible Notes – Conversion of our Convertible Notes is an event that is contingent upon numerous factors, none of which are in our control, and is an event that may or may not occur. Consistent with the treatment of other unrealized adjustments to Core Earnings, we adjust the GAAP diluted share count to exclude the potential shares issuable upon conversion until a conversion occurs.
Subsidiary equity – The intent of a February 2018 amendment to our management agreement (the “Amendment”) is to treat subsidiary equity in the same manner as if parent equity had been issued. The Class A Units issued in connection with the acquisition of assets in our Woodstar II Portfolio are currently excluded from our GAAP diluted share count, with the subsidiary equity represented as non-controlling interests in consolidated subsidiaries on our GAAP balance sheet. Consistent with the amendment, we adjust GAAP diluted share count to include these subsidiary units.
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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
2,255
1,634
Add: Woodstar II Class A Units
11,911
5,143
Less: Convertible Notes dilution
(1,209)
Diluted weighted average shares - Core
291,864
267,692
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 three months ended March 31, 2019.
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 Notes were fully repaid in shares of common stock and cash. The equity portion of the 2019 Notes had been fully amortized. In March 2018, our 4.55% Convertible Senior Notes due 2018 (the “2018 Notes”) matured and were fully repaid in cash. The equity portion of the 2018 Notes had not been fully amortized. As a result, we reflected $10.0 million as a positive adjustment to Core Earnings, representing the $28.1 million equity balance recognized upon issuance of the 2018 Notes, net of $18.1 million in adjustments related to cumulative repurchases through the maturity date.
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The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended March 31, 2019, by business segment (amounts in thousands, except per share data):
and
Costs and expenses
(69,188)
(23,846)
(67,475)
(38,674)
(54,129)
(Income) loss attributable to non-controlling interests
Add / (Deduct):
Non-controlling interests attributable to Woodstar II Class A Units
5,717
Non-cash equity compensation expense
706
551
69
1,350
3,687
Management incentive fee
173
(38)
(89)
(125)
24,211
4,915
29,197
Interest income adjustment for securities
(197)
5,972
5,775
Extinguishment of debt, net
(1,211)
Other non-cash items
(434)
137
168
(129)
Reversal of GAAP unrealized (gains) / losses on:
(1,386)
(9,880)
1,694
(18,140)
(16,446)
Derivatives
9,505
395
316
3,324
(10,144)
Foreign currency
(5,239)
(300)
(9)
(Earnings) loss from unconsolidated entities
(577)
43,805
(594)
42,634
Recognition of Core realized gains / (losses) on:
(653)
7,430
6,777
7,532
87
768
367
(1,625)
(403)
391
(891)
(483)
98
(68,905)
8,733
(60,074)
Sales of properties
(76)
Core Earnings (Loss)
3,415
(40,300)
62,775
(51,876)
82,950
Core Earnings (Loss) per Weighted Average Diluted Share
0.37
0.01
(0.14)
0.22
(0.18)
0.28
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The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended March 31, 2018, by business segment (amounts in thousands, except per share data):
(41,048)
(68,356)
(37,774)
(66,336)
(213,514)
Income attributable to non-controlling interests
2,453
563
975
3,199
4,780
9,634
119
(93)
(29)
26,805
4,912
31,734
(1,062)
(1,259)
9,755
(562)
881
443
1,692
(9,492)
704
(13,979)
(13,275)
10,529
(1,436)
(5,422)
14,398
(13,550)
(13,549)
(1,444)
3,515
(1,596)
475
Purchases and sales of properties
9,643
8,768
(4,114)
(5,725)
(479)
5,531
(673)
8,051
(41)
8,012
Earnings from unconsolidated entities
1,847
1,044
2,891
(210)
(1,765)
(1,975)
112,785
27,142
57,328
(41,419)
155,836
0.42
0.10
0.21
(0.15)
0.58
The Commercial and Residential Lending Segment’s Core Earnings decreased by $3.9 million, from $112.8 million during the first quarter of 2018 to $108.9 million in the first quarter of 2019. After making adjustments for the calculation of Core Earnings, revenues were $174.6 million, costs and expenses were $68.5 million and other income was $2.9 million.
Core revenues, consisting principally of interest income on loans, increased by $25.0 million in the first quarter of 2019, primarily due to increases in interest income from loans of $19.6 million and investment securities of $5.4 million. The increase in interest income from loans was principally due to (i) increased LIBOR rates and (ii) higher average balances of both commercial loans and residential loans held-for-sale, partially offset by (iii) lower levels of
67
prepayment related income and (iv) the compression of interest rate spreads in credit markets. The increase in interest income from investment securities was primarily due to higher average investment balances partially offset by lower levels of prepayment related income.
Core costs and expenses increased by $29.7 million in the first quarter of 2019, primarily due to a $29.6 million increase in interest expense associated with the various secured financing facilities used to fund a portion of this segment’s investment portfolio.
Core other income decreased by $0.4 million primarily due to a decrease in foreign currency gains partially offset by a decrease in related derivative losses.
The Infrastructure Lending Segment had core earnings of $3.4 million for the first quarter of 2019. After making adjustments for the calculation of Core Earnings, revenues were $28.5 million, costs and expenses were $22.5 million and other loss was $2.6 million.
Revenues of $28.5 million primarily consisted of interest income of $26.9 million from loans and $0.9 million from investment securities.
Costs and expenses of $22.5 million consisted of $18.6 million of interest expense on the secured debt facilities used to finance this segment’s investment portfolio and $3.9 million of general and administrative expenses.
Other loss of $2.6 million principally reflects a $3.3 million 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.
Core Earnings by Portfolio (amounts in thousands)
4,052
9,578
(5,526)
6,692
487
6,041
5,401
640
7,410
5,124
2,286
5,413
2,127
3,286
(1,003)
(1,293)
290
Core Earnings
(67,442)
The Property Segment’s Core Earnings decreased by $67.4 million, from earnings of $27.1 million during the first quarter of 2018 to a loss of $40.3 million in the first quarter of 2019. After making adjustments for the calculation of Core Earnings, revenues were $70.3 million, costs and expenses were $43.5 million and other loss was $66.9 million.
Core revenues increased by $3.8 million in the first quarter of 2019, primarily due to the full period inclusion of rental income from the Woodstar II Portfolio, which was acquired over a period between December 2017 and September 2018, partially offset by a decrease in rental income from the Master Lease Portfolio due to (i) no longer recording as revenues and offsetting expenses property taxes paid directly by lessees, in accordance with the new lease accounting standard effective January 1, 2019, and (ii) the sale of seven properties within the Master Lease portfolio during 2018.
Core costs and expenses increased by $1.4 million in the first quarter of 2019, primarily due to the full period inclusion of the Woodstar II Portfolio, partially offset by no longer recording property taxes paid directly by lessees and the sale of seven properties from the Master Lease Portfolio in 2018, both as discussed above.
Core other income decreased by $70.8 million in the first quarter of 2019, primarily due to a $68.9 million loss on our investment in the Retail Fund. This loss reflects the recognition of decreases in fair value of properties held by the Retail Fund which management determined to be other than temporary. Additionally, the decrease in Core other income was due to the non-recurrence of a $3.7 million realized gain on sale of two properties in the Master Lease Portfolio during the first quarter of 2018, partially offset by a $1.8 million increase in realized gains on derivatives principally attributable to interest rate swaps which hedge the variable interest rate risk on borrowings secured by our Medical Office Portfolio.
The Investing and Servicing Segment’s Core Earnings increased by $5.5 million, from $57.3 million during the first quarter of 2018 to $62.8 million in the first quarter of 2019. After making adjustments for the calculation of Core Earnings, revenues were $73.1 million, costs and expenses were $32.4 million, other income was $22.3 million, income tax provision was $0.4 million and the add-back of loss attributable to non-controlling interests was $0.2 million.
Core revenues decreased by $11.2 million in the first quarter of 2019, primarily due to decreases of $6.2 million in servicing fees, $3.1 million in interest income from our CMBS portfolio and $1.1 million in rental income from our REIS Equity Portfolio. 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.
Core costs and expenses increased by $0.4 million in the first quarter of 2019.
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 increased by $15.1 million principally due to (i) an $8.6 million lesser decrease in fair value of servicing rights, (ii) a $7.7 million increase in earnings from unconsolidated entities and (iii) a $6.7 million increase in net gains on investments reflecting increased net gains on CMBS partially offset by decreased gains on sales of operating properties, all partially offset by (iv) a $6.8 million unfavorable change in realized gains (losses) on derivatives and (v) a $2.2 million decrease in realized gains on conduit loans.
Income taxes, which principally relate to the operating results of our servicing and conduit businesses which are held in TRSs, decreased $0.3 million due to a decrease in the taxable income of our TRSs.
Income (loss) attributable to non-controlling interests decreased $1.7 million, primarily reflecting the non-recurrence of minority investors’ share of gains from three operating properties sold during the first quarter of 2018.
Core corporate costs and expenses increased by $10.5 million, from $41.4 million in the first quarter of 2018 to $51.9 million in the first quarter of 2019, primarily due to (i) an $11.0 million unfavorable change in gain (loss) on extinguishment of debt primarily due to the $10.0 million positive adjustment to Core Earnings during the first quarter of 2018 upon the repayment at maturity of the 2018 Notes, as described above, (ii) a $2.1 million increase in base management fees and (iii) a $1.9 million unfavorable change in gain (loss) on interest rate swaps, all partially offset by (iv) a $5.2 million decrease in interest expense principally on lower average outstanding balances of our unsecured senior notes.
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, 2018. Refer to our Form 10-K for a description of these strategies. Our primary sources of liquidity are as follows:
Cash Flows for the Three Months Ended March 31, 2019 (amounts in thousands)
Excluding Investing
GAAP
Adjustments
and Servicing VIEs
Net cash used in operating activities
(17,657)
(110,375)
Proceeds from principal collections and sale of loans
1,056,329
Purchase of investment securities
Proceeds from sales and collections of investment securities
10,982
45,361
56,343
(13,322)
(13,832)
Net cash flows from other investments and assets
(2,318)
Net cash used in investing activities
(7,495)
(237,076)
Proceeds from common stock issuances, net of offering costs
162
52,856
Net cash provided by financing activities
7,495
388,167
Net increase in cash, cash equivalents and restricted cash
40,716
(2,554)
485,311
(20,211)
525,773
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) 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 increased by $40.7 million during the three months ended March 31, 2019, reflecting net cash provided by financing activities of $388.2 million, partially offset by net cash used in operating activities of $110.4 million and net cash used in investing activities of $237.1 million.
Net cash used in operating activities of $110.4 million during the three months ended March 31, 2019 related primarily to $157.9 million in originations and purchases of loans held-for-sale, net of principal collections and sales,
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cash interest expense of $129.3 million, general and administrative expenses of $29.4 million, management fees of $30.0 million and a net change in operating assets and liabilities used cash of $41.4 million. Offsetting these cash outflows was cash interest income of $151.8 million from our loan origination and conduit programs and cash interest income on investment securities of $42.6 million. Net rental income provided cash of $52.1 million and servicing fees provided cash of $25.8 million.
Net cash used in investing activities of $237.1 million during the three months ended March 31, 2019 related primarily to the origination and acquisition of new loans held-for-investment of $1.3 billion, the purchase of investment securities of $39.5 million, investments in unconsolidated entities of $13.8 million and net additions to properties and other assets of $7.1 million, partially offset by the proceeds received from principal collections and sales of loans of $1.1 billion and proceeds received from principal collections and sales of investment securities of $56.3 million.
Net cash provided by financing activities of $388.2 million for the three months ended March 31, 2019 related primarily to borrowings on our secured debt, net of repayments and deferred loan costs, of $537.8 million, partially offset by dividend distributions of $132.5 million, the settlement of the 2019 Notes of $10.4 million and net distributions to non-controlling interests of $6.9 million.
Our Investment Portfolio
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 March 31, 2019 and December 31, 2018 (dollars in thousands):
Unlevered
Asset Specific
Return on
Investment
Vintage
Asset
First mortgages (1)
6,873,026
6,850,339
4,119,304
2,731,035
1997-2019
Subordinated mortgages
1998-2018
9.4
Mezzanine loans (1)
2005-2018
12.8
Other loans
1999-2018
9.0
499,850
188,585
2013-2019
(30,788)
89,092
115,743
2003-2007
11.8
RMBS, fair value option
72,339
33,192
75,624
2018-2019
8.4
CMBS, fair value option
150,938
150,677
80,391
70,286
HTM debt securities (4)
585,613
584,177
189,129
395,048
2014-2018
7.5
11,910
9,369,819
9,306,864
4,295,906
6,627,879
6,603,760
3,542,214
3,061,546
1997-2018
7.0
9.1
499,756
123,904
2013-2018
Loans held-for-sale, commercial
48,667
46,495
30,525
15,970
107
44,070
165,009
11.7
62,397
13,179
74,700
8.0
160,198
158,688
83,864
74,824
585,017
583,381
191,991
391,390
11,660
9,002,971
8,902,915
4,479,838
4,423,077
72
Includes $108.8 million and $87.9 million of RMBS eliminated in consolidation against VIE liabilities pursuant to ASC 810 as of March 31, 2019 and December 31, 2018, respectively.
Includes $150.7 million and $158.7 million of CMBS eliminated in consolidation against VIE liabilities pursuant to ASC 810 as of March 31, 2019 and December 31, 2018, respectively.
CMBS held-to-maturity (“HTM”) and mandatorily redeemable preferred equity interests in commercial real estate entities.
As of March 31, 2019 and December 31, 2018, our Commercial and Residential Lending Segment’s investment portfolio, excluding loans held-for-sale, RMBS, properties and other investments, had the following characteristics based on carrying values:
Collateral Property Type
Office
37.1
35.0
Hotel
21.7
23.5
Mixed Use
14.9
11.9
Multifamily
15.4
5.2
4.9
Retail
2.4
Industrial
1.5
4.3
Geographic Location
North East
27.8
28.7
West
21.3
22.7
International
14.7
11.0
South West
13.9
14.0
South East
9.9
Mid Atlantic
6.5
6.8
Midwest
6.4
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The following table sets forth the amount of each category of investments we owned within our Infrastructure Lending Segment as of March 31, 2019 and December 31, 2018 (dollars in thousands):
First priority infrastructure loans and HTM securities
1,531,376
1,509,707
1,117,472
392,235
292,652
10,925
3.6
(774)
1,843,927
1,812,510
402,386
1,537,412
1,517,547
1,130,567
386,980
5.9
393,984
75,791
2,024,321
1,987,322
462,771
As of March 31, 2019 and December 31, 2018, our Infrastructure Lending Segment’s investment portfolio had the following characteristics based on carrying values:
Collateral Type
Natural gas power
69.2
54.3
Renewable power
16.3
30.8
Midstream/downstream oil & gas
8.7
9.3
Other thermal power
5.6
Upstream oil & gas
0.2
0.5
U.S. Regions:
43.8
32.8
19.3
15.9
7.6
12.9
Mid-Atlantic
3.9
4.6
3.4
3.3
International:
Mexico
12.5
United Kingdom
Ireland
4.2
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The following table sets forth the amount of each category of investments, which are comprised of properties, intangible lease assets and liabilities and our equity investment in the Retail Fund held within our Property Segment as of March 31, 2019 and December 31, 2018 (amounts in thousands):
Lease intangibles, net
82,469
87,729
2,640,311
2,714,938
The following table sets forth our net investment and other information regarding the Property Segment’s properties and intangible lease assets and liabilities as of March 31, 2019 (dollars in thousands):
Specific
Occupancy
Lease Term
Office—Medical Office Portfolio
760,366
486,831
273,535
93.3
6.3 years
Office—Ireland Portfolio
494,086
341,626
152,460
99.0
9.3 years
Multifamily residential—Ireland Portfolio
17,908
11,626
6,282
96.0
0.4 years
Multifamily residential—Woodstar I Portfolio
624,427
406,783
217,644
98.3
0.5 years
Multifamily residential—Woodstar II Portfolio
599,361
437,494
161,867
99.5
Retail—Master Lease Portfolio
343,790
192,154
151,636
23.1 years
Subtotal—undepreciated carrying value
2,839,938
963,424
Accumulated depreciation and amortization
(270,184)
Net carrying value
2,569,754
693,240
As of March 31, 2019 and December 31, 2018, our Property Segment’s investment portfolio had the following geographic characteristics based on carrying values:
17.4
17.7
51.0
50.8
8.6
8.3
8.1
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The following table sets forth the amount of each category of investments we owned within our Investing and Servicing Segment as of March 31, 2019 and December 31, 2018 (amounts in thousands):
2,821,996
308,137
684,602
Intangible assets - servicing rights
44,117
27,621
109,442
43,810
235,499
37,653
2,972,922
1,546,630
893,552
2,872,381
320,158
678,662
44,632
29,327
46,249
34,105
13,517
230,995
2,921,987
1,439,930
854,672
Includes $943.6 million and $957.5 million of CMBS eliminated in consolidation against VIE liabilities pursuant to ASC 810 as of March 31, 2019 and December 31, 2018, respectively.
Includes $24.3 million and $24.1 million of servicing rights intangibles eliminated in consolidation against VIE assets pursuant to ASC 810 as of March 31, 2019 and December 31, 2018, respectively.
Includes $35.8 million and $22.0 million of investment in unconsolidated entities eliminated in consolidation against VIE assets pursuant to ASC 810 as of March 31, 2019 and December 31, 2018, respectively.
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Our REIS Equity Portfolio, as described in Note 6 to the Condensed Consolidated Financial Statements, had the following characteristics based on carrying values of $284.7 million as of both March 31, 2019 and December 31, 2018:
Property Type
56.7
56.5
24.1
7.7
7.8
Self-storage
37.9
22.4
17.8
18.0
9.8
5.3
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, 2018.
Borrowings under Various Secured Financing Arrangements
The following table is a summary of our secured financing facilities as of March 31, 2019 (dollars in thousands):
Approved
but
Unallocated
Facility
Outstanding
Undrawn
Size
Balance
Capacity (b)
Amount (c)
1,341,314
658,686
37,362
395,248
50,200
285,163
238,709
13,644
150,936
4,360
50,000
229,310
73,750
93,876
108,720
131,116
(k)
32,917
7,083
94,611
19,034
31,671
(l)
352,650
15,257,333
270,479
Approved but undrawn capacity represents the total draw amount that has been approved by the lender related to those assets that have been pledged as collateral, less the drawn amount.
Unallocated financing amount represents the maximum facility size less the total draw capacity that has been approved by the lender.
The initial maximum facility size of $600.0 million may be increased to $900.0 million at our option, subject to certain conditions.
As of March 31, 2019, Wells Fargo Bank, N.A. is our largest repurchase facility creditor through the Lender 1 Repo 1 facility and the MBS Repo 4 facility.
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
8,761,624
8,885,381
(123,757)
9,766,206
(460,601)
Variance primarily due to the following: (i) $83.0 million repaid on the Lender 4 Repo 2 facility in December 2018; and (ii) $37.0 million repaid on the Lender 2 Repo 1 facility in December 2018.
Variance primarily due to the late quarter timing of commercial loan sales and loan repayments, all of which resulted in paydowns of the corresponding credit facilities which financed these assets.
Borrowings under Unsecured Senior Notes
During the three months ended March 31, 2019 and 2018, the weighted average effective borrowing rate on our unsecured senior notes was 5.0% and 4.9%, respectively. 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.
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Scheduled Principal Repayments on Investments and Overhang on Financing Facilities
The following scheduled and/or projected principal repayments on our investments were based upon the amounts outstanding and contractual terms of the financing facilities in effect as of March 31, 2019 (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
Second Quarter 2019
648,639
10,088
(163,600)
495,127
Third Quarter 2019
436,540
35,626
(60,162)
412,004
Fourth Quarter 2019
682,021
14,261
(192,083)
504,199
First Quarter 2020
867,912
16,346
(599,438)
284,820
2,635,112
76,321
(1,015,283)
1,696,150
Includes $428.4 million of repayments associated with a secured financing facility that carries a rolling 12-month term which may reset monthly with the lender’s consent.
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 March 31, 2019, we had 100,000,000 shares of preferred stock available for issuance and 219,698,655 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 certain investment securities which no longer meet our return requirements.
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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
We intend to continue to make regular quarterly distributions to holders of our common stock. 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 intend to continue to pay regular quarterly dividends to our stockholders in an amount approximating our net taxable income, 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 three months ended March 31, 2019:
Declare Date
Leverage Policies
Our strategies with regards to use of leverage have not changed significantly since December 31, 2018. Refer to our Form 10-K for a description of our strategies regarding use of leverage.
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Contractual Obligations and Commitments
Contractual obligations as of March 31, 2019 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)
770,161
2,672,125
Loan funding commitments (b)
1,727,378
586,184
61,113
Infrastructure Lending Segment commitments (c)
341,803
338,962
2,841
Future lease commitments
26,509
6,519
7,840
656
11,494
13,351,295
3,183,619
Represents the contractual maturity of the respective credit facility, inclusive of available extension options. If investments that have been pledged as collateral repay earlier than the contractual maturity of the debt, the related portion of the debt would likewise require earlier repayment. Refer to Note 9 to the Condensed Consolidated Financial Statements for the expected maturities by year.
Excludes $212.4 million of loan funding commitments in which management projects the Company will not be obligated to fund in the future due to repayments made by the borrower earlier than, or in excess of, expectations.
Represents contractual commitments of $221.0 million under revolvers and letters of credit and $120.8 million under delayed draw term loans.
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
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. Our critical accounting estimates have not materially changed since December 31, 2018.
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 have not changed materially since December 31, 2018. Refer to our Form 10-K, Item 7A for further discussion.
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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 Manager’s 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 March 31, 2019 and December 31, 2018 (dollars in thousands):
Face Value of
Aggregate Notional Value of
Number of
Loans Held-for-Sale
Credit Index Instruments
24,000
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.
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 March 31, 2019 and December 31, 2018 (dollars in thousands):
Aggregate Notional
Value of Interest
Number of Interest
Hedged Instruments
Rate Derivatives
Instrument hedged as of March 31, 2019
449,428
443,400
109,000
Secured financing agreements
726,625
690,176
2,478,282
2,212,576
Instrument hedged as of December 31, 2018
346,300
337,700
1,085,717
1,029,376
2,741,514
2,446,076
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The following table summarizes the estimated annual change in net investment income for our LIBOR-based investments and our LIBOR-based debt assuming increases or decreases in LIBOR and adjusted for the effects of our interest rate hedging activities (amounts in thousands, except per share data):
Variable rate
investments and
3.0%
2.0%
1.0%
Income (Expense) Subject to Interest Rate Sensitivity
indebtedness (1)
Increase
Decrease (2)
Investment income from variable rate investments
9,397,840
277,030
184,255
91,480
Interest expense from variable rate debt, net of interest rate derivatives
(7,275,650)
(219,952)
(146,921)
(73,786)
74,082
Net investment income from variable rate instruments
2,122,190
57,078
37,334
17,694
(103)
Impact per diluted shares outstanding
0.20
0.13
0.06
Includes the notional value of interest rate derivatives.
Assumes LIBOR does not go below 0%.
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 March 31, 2019 GBP closing rate of 1.3031, Euro (“EUR”) closing rate of 1.1219, Canadian Dollar (“CAD”) closing rate of 0.7494, and Australian Dollar (“AUD”) closing rate of 0.7094.
Carrying Value of Net Investment
Local Currency
Number of Foreign Exchange Contracts
Aggregate Notional Value of Hedges Applied
Expiration Range of Contracts
3,605
4,206
April 2019
74,789
73,272
April 2019 – June 2020
7,827
11,028
26,531
33,548
April 2019 – July 2021
31,587
36,926
May 2020 – March 2022
18,927
29,477
May 2019 – August 2022
3,005
4,117
92,995
116,946
23,829
59,573
April 2021
3,621
5,335
6,443
2,252
5,948
July 2019 – October 2022
157,119
232,574
June 2019 – June 2020
36,352
June 2019 – December 2021
56,736
77,893
May 2019 – November 2021
April 2020
1,613
550,425
216
745,548
These foreign exchange contracts hedge our EUR currency exposure created by our acquisition of the Ireland Portfolio.
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 March 31, 2019 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.
There have been no material changes to the risk factors previously disclosed in our Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
There were no unregistered sales of securities during the three months ended March 31, 2019.
Issuer Purchases of Equity Securities
There were no purchases of common stock during the three months ended March 31, 2019.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Item 6. Exhibits.
(a)Index to Exhibits
INDEX TO EXHIBITS
Exhibit No.
Description
Master Repurchase and Securities Contract, dated as of February 6, 2019, among SPT Infrastructure Finance Sub-4, LLC, SPT Infrastructure Finance Sub-4 (DT), LLC, SPT Infrastructure Finance Sub-4 (OT), Ltd. and MUFG Bank, Ltd.
Amended and Restated Advances, Collateral Pledge and Security Agreement, dated as of July 7, 2017, between the Federal Home Loan Bank of Chicago (“FHLB”) and Prospect Mortgage Insurance, LLC (“PMI”) (the “Amended and Restated Advances, Collateral Pledge and Security Agreement”)
Supplement to Amended and Restated Advances, Collateral Pledge and Security Agreement, dated as of July 7, 2017, among PMI, SMRF Trust III (the “SMRF Trust III”), SMRF Trust III-A (“SMRF Trust III-A”, and together with SMRF Trust III, the “Trusts”), Wilmington Trust, National Association, solely as Delaware Trustee of the Trusts, and the FHLB (the “Supplement to Amended and Restated Advances, Collateral Pledge and Security Agreement”)
Letter agreement, dated March 15, 2019, between PMI and FHLB supplementing the Amended and Restated Advances, Collateral Pledge and Security Agreement dated July 7, 2017 and the Supplement to Amended and Restated Advances, Collateral Pledge and Security Agreement dated July 7, 2017, between PMI and the FHLB
Sixth Amended and Restated Master Repurchase and Securities Contract, dated as of April 10, 2019, among Starwood Property Mortgage Sub-2, L.L.C., Starwood Property Mortgage Sub-2-A, L.L.C. and SPT CA Fundings 2, LLC, as sellers, and Wells Fargo, National Association, as buyer
Second Amendment, dated as of April 11, 2019, to the Third Amended and Restated Credit Agreement, dated as of February 28, 2018, among Starwood Property Mortgage Sub-10, L.L.C. and Starwood Property Mortgage Sub-10-A, L.L.C., as borrowers, Starwood Property Trust, Inc. and certain subsidiaries of thereof as guarantors, the lenders from time to time party thereto and Bank of America, N.A., as administrative agent thereunder
Form of Restricted Stock Award Agreement
Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
*Indicates management contract or compensatory plan or arrangement.
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: May 8, 2019
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