STARWOOD PROPERTY TRUST, INC. 2026 Q2 Earnings Call

Thank you, operator. Good morning, and welcome to Starwood Property Trust earnings call. This morning, we filed our 10-Q and issued a press release with a presentation of our results, which are both available on our website and have been filed with the SEC. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are forward-looking statements, which do not guarantee future events or performance. Please refer to our 10-Q and press release for cautionary factors related to these statements. Additionally, certain non-GAAP financial measures will be discussed on this call. For reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP, please refer to our press release filed this morning.

Joining me on the call today are Barry Sternlicht, the company's chairman and chief executive officer, Jeff DiModica, the company's president, and Rina Paniry, the company's chief financial officer. With that, I am now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. Our distributable earnings were $152 million, or $0.40 per share in the second quarter. Our results continue to reflect the carry on our non-accrual and REO assets and elevated cash balances, the two items which are creating the gap between our reported earnings and the true underlying earnings power of this company. I will start my remarks by addressing both. Regarding our non-accrual and REO, we had no new non-accrual or new 5-rated loans in the quarter or the year. We also had no new REO in the quarter. As our new non-accrual and REO loans have slowed, we have gained momentum in resolutions. To clarify, our definition of resolution means disposition of the asset in the case of an REO or returning to accrual in the case of a non-accrual loan. It is not the transfer of a loan to REO.

We have a total of $706 million of reserves against our non-accrual and REO assets after recording an increase of $30 million in the quarter due to third-party modeled macroeconomic conditions which worsened as a result of the rise in interest rates. This consists of $485 million of CECL and $221 million of REO reserves, which translate to $1.97 per share that is already reflected in today's undepreciated book value of $18.62. As we continue our efforts to resolve these underperforming assets. We are currently under contract or in discussions to sell three REO assets and multiple units in our New York City residential project. In aggregate, these sales are expected to generate cash proceeds of $148 million and resolve $195 million of assets on a DE basis and $160 million on a GAAP basis in the third quarter, comprising 10% of our current non-accrual and REO balance.

One of the three assets was retraded recently due to rate increases, resulting in a $12 million divergence from our GAAP marks. Absent that, our GAAP reserves were in line with the anticipated sales price, demonstrating our ability to fully resolve these assets consistent with our estimates. The realized loss will flow through DE upon sale in Q3 and totals approximately $47 million for these assets. As a reminder, when assets are resolved at our carrying value, their reserves naturally progress to DE, but the reserve is already accounted for in our book value. Reinvesting these proceeds would add approximately $0.03 to annual DE as we continue on our path to earning our dividend in our core businesses.

Our total non-accrual and REO portfolio stands at approximately $1.9 billion on a DE basis at quarter end, not including the $706 million of reserves that are already reflected in book value. Subject to market conditions, we are on track to resolve approximately $800 million or 40% of our current non-accrual and REO by year-end. Regarding elevated cash balances, we were especially active in the capital markets this quarter, issuing $1.1 billion of unsecured senior notes and upsizing our Term Loan B by $275 million. Offsetting this elevated cash was our accelerated investing pace as we deployed capital of $2.5 billion across our businesses and another $1.7 billion in July, bringing year-to-date investments to $6.7 billion. I will now take you through our individual segment results, beginning with commercial and residential lending, which contributed DE of $186 million to the quarter or $0.49 per share.

In commercial lending, we originated $1.4 billion, of which we funded $754 million and another $250 million of preexisting loan commitments for a total of over $1 billion funded in the quarter. After factoring in repayments of $447 million, our funded loan portfolio grew to a record $17.3 billion. We received another $554 million of repayments in July, approximately $170 million of which were office. I previously mentioned the absence of any new REO, nonaccrual, or five-rated loans this quarter. Our four-rated loans increased $212 million to $2 billion, reflecting the downgrade of three multifamily loans that Jeff will speak to. Turning to residential lending, our on-balance sheet loan portfolio ended the quarter at $2.4 billion, up $164 million, driven primarily by our decision to exercise the call option on one of our securitizations, moving the majority of the financing to more attractively priced repo at SOFR plus 150.

As a result, our retained RMBS portfolio declined to $313 million at quarter end. Turning to our property segment, we recognized $34 million of DE, or $0.09 per share, across our legacy and net lease portfolios. I will start with Woodstar, our Florida affordable multifamily portfolio. On July 1st, we began rolling out the new authorized HUD rent increases of 8.4% that we mentioned to you on our last call. The related earnings impact will appear in our results starting next quarter. The discount to market rate rents across the portfolio is 38% on average, which should ensure continued high occupancy and allow us to push through most of these rent increases. Also in Woodstar, we have $416 million of Woodstar debt maturing over the next six months that we are currently working to refinance.

Given the appreciation and NOI growth in this portfolio, we are anticipating an upsize of approximately $140 million at attractive spreads or $110 million share of which can be reinvested to increase future earnings. In net lease, where DE increased to $0.05 from $0.03 last quarter, we closed $179 million of purchases in the quarter at a blended cap rate of 7.39%, bringing our total post-acquisition purchases to $532 million at a blended 7.45% cap rate. The portfolio now stands at $2.7 billion, comprising 527 properties across 44 states, a weighted average lease term of 16.8 years, average annual rent escalations of 2.3%, and 100% occupancy with zero defaults. Included in our balance at June 30th are $91 million of build-to-suit projects still under construction, with $65 million of incremental cost to complete. All of these projects are subject to executed leases.

Upon completion of construction, these leases will add $9.9 million of annual base rent to revenue. We continue to optimize this platform's capital structure, completing another ABS transaction after quarter end, our third securitization since acquiring the platform a year ago. The ABS financing totaled $321 million at a weighted average fixed rate of 5.47%. With our continued optimization of the capital structure, our first year of rent escalations in place, and our investing pace, we continue to build toward the earnings power embedded in this platform. Concluding my business segment discussion is our Investing and Servicing segment, which contributed DE of $42 million, or $0.11 per share to the quarter. Special servicing fees were $20 million this quarter, with the decline from last quarter due to timing of resolutions.

Our conduit, Starwood Mortgage Capital, securitized $320 million of loans, more than double last quarter's volume, at profit margins that were in line with historic levels. I will conclude with a comment on this segment's REO equity portfolio, which now has just five assets remaining. We sold one asset during the quarter for a DE gain of $2 million. Turning to liquidity and capitalization, our current liquidity stands at $1.2 billion. This does not include liquidity that could be generated from cash-out refinancing, sales of assets in our property segment, direct leveraging, or expected proceeds from REO sales, which, as I've mentioned, could be relatively material. Jeff will discuss the capital markets transactions we completed in the quarter. There is one item I would like to highlight regarding the early redemption of our $500 million January 2027 unsecured debt, which was subject to an interest rate hedge.

In order to minimize interest rate risk, our policy is to hedge floating rate assets with floating rate liabilities and fixed rate assets with fixed rate liabilities. When we issued these notes in 2022 to a fixed coupon, we entered into a receive fixed pay floating interest rate hedge to lock in SOFR plus 295 as a financing cost. In connection with the early redemption, we unwound the hedge. Due to higher interest rates today, this resulted in a loss on early extinguishment of debt of $6.3 million, which will be reflected in both GAAP and DE in the third quarter. The amount represents the present value of receiving the below-market fixed rate through maturity.