Starwood Property Trust - Earnings Call - Q2 2020

Transcript

Operator (participant)

Greetings and welcome to the Starwood Property Trust Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Mr. Zack Tanenbaum, Director of Investor Relations for Starwood Property Trust. Thank you. You may begin.

Zack Tanenbaum (Director of Investor Relations)

Thank you, Operator. Good morning and welcome to Starwood Property Trust earnings call. This morning, the company released its financial results for the quarter ended June 30th, 2020, filed Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the Investor Relations section of the company's website at www.starwoodpropertytrust.com. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

Joining me on the call today are Barry Sternlicht, the company's Chairman and Chief Executive Officer, Jeff Dimodica, the company's President, Rina Paniry, the company's Chief Financial Officer, and Andrew Sossen, the company's Chief Operating Officer. With that, I am now going to turn the call over to Rina.

Rina Paniry (CFO)

Thank you, Zack, and good morning, everyone. For the second quarter, we reported core earnings of $126 million or $0.43 per share. As we proactively managed the initial market impact from COVID-19, we quickly moved our balance sheet into a more defensive position. When we last spoke in early May, we had already delivered our balance sheet and increased our cash position significantly. Although prudent in the face of unprecedented market volatility, this strategy created over $1 billion of balance sheet inefficiency, which came at a cost to earnings in the quarter and continues to have an impact today. GAAP earnings for the quarter was $140 million or $0.49 per share. This led to a $0.03 increase in our GAAP book value per share to $15.79 and a $0.09 increase in undepreciated book value per share to $17.03.

Our book value per share includes year-to-date declines of $0.32 related to CESOL and $0.38 related to mark-to-market adjustments on our assets. These amounts do not reflect the fair value of the assets in our property portfolio, which we continue to believe have appreciated meaningfully since we acquired them. This is demonstrated by our continued refinancings of these assets, which I will touch on later. Despite the macroeconomic headwinds we faced this quarter, the power of our diverse platform was evident, with each of our business lines contributing to earnings and liquidity. I will begin with our largest segment, commercial and residential lending, which contributed core earnings of $112 million to the quarter. On the commercial lending side, we selectively originated $198 million of loans with a weighted average LTV of 44%, $156 million of which was funded. We also funded $220 million under pre-existing loan commitments.

These cash outflows of $376 million were more than offset by $566 million of cash inflows resulting from sales and repayments. During the quarter, we sold three loans at par: two A-notes for $225 million and one whole loan for $172 million. We also received $169 million in loan repayments, which brought our commercial lending portfolio to $9.4 billion. The A-note and whole loan sales, two of which were construction loans, contributed to a 26% reduction in our future funding exposure this quarter. Our quarterly interest collections were strong at 98%, 6% of which were deferred or pending deferral as part of COVID-related loan modifications. We have modified 11 loans to date, representing $6 million of deferred interest in the quarter, and we are working to modify one additional loan.

These modifications were short-term, generally permitted only the partial deferral of interest, and were often coupled with additional equity commitments from our sponsors. With respect to our CESOL reserve, we had no loans which warranted a loan-specific reserve or a change to non-accrual status. The slight increase of $11 million in our general reserve was primarily the result of macroeconomic conditions in our CESOL forecast model, as well as changes in estimated repayment timing. The credit quality of our portfolio remained strong, with a weighted average LTV of 61%. As a reminder, our business continues to be positively correlated to changes in interest rates, with 93% of our commercial portfolio being floating rate. As of quarter end, $6.2 billion of our loans benefited from having a weighted average Libor floor of 157 basis points.

Turning to the residential lending side of this segment, we completed our seventh and largest non-QM securitization to date, totaling $584 million. In connection with this transaction, we retained $185 million of RMBS, bringing the balance of our RMBS portfolio to $328 million at quarter end. Although we recognized a $5 million securitization loss, we were able to de-risk our balance sheet and improve our liquidity position by selling these loans into an off-balance sheet structure with no recourse and no spread mark risk. As we continue to expand this business, we entered into an agreement early in the quarter to acquire up to $558 million of non-QM loans at a discount. Although none had been purchased by quarter end, we intend to simultaneously acquire and sell approximately $470 million of these loans into our eighth securitization in the coming weeks.

Separate from this agreement, we acquired $135 million of non-QM loans during the quarter and $245 million subsequent to quarter end, all at discounts to par. Our residential loan portfolio ended the quarter with a balance of $700 million, a weighted average coupon of 6.2%, an average LTV of 67%, and an average FICO of 730. Last quarter, we spoke about the significant spread widening that these loans experienced in late March. Since then, they have mostly recovered, with $33 million of last quarter's $35 million mark-to-market decrease being reversed through a GAAP mark-to-market increase this quarter. Next, I will discuss our property segment, which contributed $18 million of core earnings to the quarter. The portfolio continues to perform very well, with blended cash-on-cash yields increasing to 15.7% this quarter. Rent collections were strong at 97%, and weighted average occupancy remained steady at 97%.

Core earnings included a $2 million loss on extinguishment of debt related to the refinancing of 12 assets in Woodstar One, our first affordable housing portfolio in Florida. We obtained debt of $217 million with a 10-year term at a spread of 271 basis points over Libor, which we capped at 1%. This allowed us to return $100 million in proceeds and reduce our basis in this portfolio to just $30 million from $169 million at acquisition. In connection with the refinancing, we obtained appraisals, which valued the assets at a 4.64% cap rate. The fair values in our supplemental reporting package reflect this portfolio at a 4.75% cap rate. Our acquisition cap rate was 6.16%. Next, I will discuss our investing and servicing segment, which contributed core earnings of $37 million to the quarter.

This amount includes $10 million related to the partial sale of our minority stake in Cytis, the real estate advisory company that we acquired an interest in during 2016 when we disposed of our European servicer. During the quarter, we received cash of $10 million related to the partial sale, which resulted in a realized GAAP and core gain. We also recognized an unrealized GAAP gain of $18 million to increase our remaining investment to its implied fair value. In our special servicing business, $2.8 billion of loans transferred into special servicing during the quarter, bringing our active servicing portfolio to $8 billion at June 30th. These transfers contributed to the $5 million increase in the servicing intangible that we recognized this quarter. Despite the large volume of transfers into servicing, we did not receive any significant COVID-related fees.

Given the current environment, we expect to see longer resolution times for these assets, which will result in delayed fee recognition. In our conduit, we waited for the securitization markets to recover before attempting to securitize our pre-COVID portfolio. Although we had no securitizations during the quarter, last week we securitized $151 million of loans for a slight loss of 0.6%. We also collected 100% of interest due in the quarter, and finally, regarding our properties in this segment, in April, we sold an office property in North Carolina for gross proceeds of $24 million, resulting in a GAAP gain of $7 million and a core gain of $2 million. Concluding my business segment discussion is our infrastructure lending segment, which contributed core earnings of $5 million to the quarter.

The portfolio was relatively flat over last quarter at $1.6 billion, with $51 million of fundings under pre-existing loan commitments slightly outpacing repayments of $36 million. The lower coupon loans we acquired from GE represent $726 million of this amount, a 64% decrease since acquisition. We continue to be pleased with the credit performance of this portfolio, which had no margin calls and 100% interest collections in the quarter. In addition, subsequent to quarter end, we extended a $500 million financing facility by 12 months to February 2022. I will conclude this morning with a few comments about our liquidity and capitalization. We continue to have ample credit capacity across our business lines. We ended the quarter with an undrawn debt capacity of $9.5 billion and an adjusted debt-to-undepreciated equity ratio of 2x. We also had $2.9 billion of unencumbered assets.

As of Friday, we had $821 million of cash and approved undrawn debt capacity. This amount is after payment of our second quarter dividend and after $347 million of deleveraging across our facilities. The deleveraging includes voluntary paydowns of $173 million on seven of our warehouse lines, where we have obtained margin call moratoriums on certain assets. With that, I'll turn the call over to Jeff for his comments.

Jeff Dimodica (President)

Thanks, Rina, and good morning, everyone. I'd like to start by congratulating Rina, Zack, and the rest of our team for being awarded the Nareit Investor Care Award for the seventh straight year. The award is given to only one company in our space each year for excellence in reporting and shareholder communications, and we are proud to have been voted it by our shareholders and analysts for seven straight years. Although some of our company has been working remotely, I've been back in the office along with the senior management team since our last call, and have to say, it's been nice to have some part of life feel normal again. Since COVID began, we've worked hard to strengthen our balance sheet by both deleveraging our business and significantly reducing our future obligations.

Inclusive of our deleveraging, we have been sitting on over $700 million of cash on most days since COVID began, and over $800 million today, as Rina said. This liquidity has given us the ability to go cautiously on offense, purchasing or agreeing to purchase approximately $700 million worth of low loan-to-value residential mortgage loans made to high-quality borrowers at large discounts to par near the bottom of the COVID pricing dip. We can securitize those loans today well above par, reducing the net permanent required equity on these purchases to less than $50 million. We have also selectively written CRE loans and have an actionable pipeline of accretive large loans we plan to execute on in the second half of 2020. We are investing today, but we'll maintain a balance of caution and maintain ample liquidity to weather any future tremors if this recovery stalls.

With both $500 million of senior secured notes maturing and our Federal Home Loan Bank membership set to expire in February, we are preparing our balance sheet today for both events. With our recent securitizations, we have reduced our FHLB borrowings by two-thirds, leaving only $342 million currently drawn, and we will have the ability to move any remaining balances to over $1 billion of new bank lines that are expected to close in the coming weeks or to securitization financing over the coming months, leaving us with tremendous capacity to continue to grow our residential lending business. As for the senior unsecured notes, they cannot be prepaid until November first.

We plan to hold ample cash to be able to pay them off should the capital markets not be open or efficient, but our plan today, with credit spreads improving dramatically, is to raise debt capital in the fall through either a term loan B upsized, new senior unsecured notes, or some combination of both. Now I'd like to discuss our performance and opportunity set by segment as we expect to deploy capital in each segment this quarter. In our large loan lending book, we are rebuilding our loan pipeline. Going forward, we expect to continue financing more than half of our CRE loan portfolio off balance sheet as we did pre-COVID. Our post-COVID playbook also includes prioritizing more stabilized assets with smaller future funding components that are in the more resilient sectors of CRE lending that we think will outperform during and after COVID-19.

As Rina said, during the quarter, we both deleveraged our borrowings and continued to sell senior A-Note mortgages to obtain efficient off-balance sheet financing with no mark-to-market features. For liquidity planning purposes, we conservatively extended management's expected loan repayment dates and are now modeling that less than 4% of our loan book repays in the second half of 2020, as well as significantly less in 2021 than we previously forecasted. Given less loans could pay off in the coming 18 months, we actively reduced our future funding requirements in the quarter to be sure we can easily cover those fundings in cash if no loans are repaid, which is a very draconian assumption that I'm sure we will be wrong on. A-Note sales and par loan sales executed in the quarter helped reduce future funding in our CRE portfolio by over $700 million in the quarter.

Our gross funding obligations are down 35% today versus where they were just last quarter. In net of bank financings, our future funding is below a very manageable $1 billion and spread out over the coming three-plus years. Historically, approximately two-thirds of our future funding requirements are on construction loans, and one-third is what we call good news money, or the future funding of new lease tenant improvements and leasing commissions on cash-flowing properties. Providing this good news money generally de-risks your loan as the sponsor is executed on your underwritten business plan. By the end of this quarter, assuming no new construction loans were made, we expect to have managed our construction exposure as a percentage of lending segment assets down 32% versus the first quarter to just mid- to low-teens percent of lending segment assets.

Of note, 30% of our construction loans are fully leased to investment-grade tenants: Facebook, AmerisourceBergen, and British Telecom. We are happy during this unprecedented period to have been able to proactively reduce our future funding requirements so significantly and without selling any loans, securities, or other assets below par, nor did we need to raise expensive or diluted capital. The two-thirds of our loan book that have Libor floors above zero have an average floor of 1.57%, approximately 140 basis points above Libor today, giving them a value of over $150 million today. These floors could be sold to create incremental cash should we ever choose to.

Given our liquidity position, we were early and aggressive in deleveraging warehouse lines in exchange for margin call holidays on 94% of our hotels and a few other assets, allowing us flexibility to modify the majority of our COVID-affected hotel loans, which include new sponsor equity, ability to use reserves, and, as Rina mentioned, some short-term interest deferrals where appropriate. Our best-in-class sponsors have contributed over $150 million of fresh equity since COVID began and are projected to contribute another $150 million of fresh equity in the second half of 2020 for over $300 million of current and future equity contributions in total. Importantly, 20% of our hotel exposure is in extended-stay hotels, which have significantly outperformed other hotel segments and averaged over 80% occupancy during COVID.

Finally, in lending, we are pleased that Amazon signed a lease for 100% of our one million sq ft Orlando distribution center, formerly leased by Winn-Dixie, and is moving in equipment as we speak. We took an $8 million reserve when we foreclosed on the other former Winn-Dixie asset we own in Montgomery, Alabama, and have since leased the entirety of that one million sq ft facility to Dollar General. We are pleased that due to our leasing efforts, within a year of taking over both empty properties, we went from taking a reserve to creating tens of millions in gains that we will realize in future quarters. Moving to our REZI non-QM business, since COVID began, we purchased or agreed to purchase approximately $700 million in loans significantly below par.

Prices on these fixed-rate loans have recovered to above par today and are projected to generate large taxable gains in our portfolio in the coming quarters. We priced our eighth securitization this week, our second securitization since COVID began. These transactions raised over $1 billion of non-recourse fixed-rate financing and continue to show the resiliency of our Star securitization platform's access to financing, even in difficult markets, for our target high FICO, low LTV assets. Our unsecuritized whole loan balance is down to $700 million today versus $1.2 billion last quarter, and we expect that to fall to less than $300 million after our next securitization, which is planned in Q3.

Coming weeks, we will have executed three new bank warehouse lines with nearly two times the capacity of our existing FHLB borrowings, with pricing and structural terms that give us significant capacity to continue to grow this business at attractive return profiles. Although we expect the pace of originations to slow in the second half of 2020, we believe our residential platform is well-positioned to grow market share in the coming quarters. In our energy infrastructure business, SIF, we have told you that we invest away from the commodity wellhead and are therefore not highly correlated to commodity prices. Despite significant commodity price volatility in early COVID, as Rina said, our $1.85 billion loan book has had very strong credit performance, has not had any voluntary or involuntary deleveraging to date, and had 100% interest collections to date.

Unlike our CRE loans, these loans don't have embedded interest rate floors, so lower Libor has reduced our interest income, but we see good opportunities on the horizon to invest accretively with attractive post-COVID spreads on new issue loans. In order to continue to invest, we continue to add to and extend our financing availability in the quarter and continue to look at CLO execution economics that will allow us to move more financing off balance sheet in the coming year. Rina talked about our REIF segment, and I will add that in addition to repurposing employees to help manage the onslaught of new special servicing opportunities that will create revenues for the next 10 years, we have also seen attractive yields on new B-notes investments today on very high-quality post-COVID originations.

Finally, in our property book, after remarking our book, we believe we still have well over $700 million of gains. Over 85% of those gains are in our very stable 15,000-unit Florida multifamily portfolio. With that, I will turn the call to Barry.

Barry Sternlicht (Chairman and CEO)

Thank you, Jeff. Thank you, Rina. Thank you, Andrew and thanks, everyone, for dialing in this morning. It's hard to add a lot to what Rina and Jeff have said. I think my quote in the earnings release reflects my view that we're kind of at the Indianapolis Speedway, and the pit car, I guess they call it, is out, and we're lapping around the track and all of the mortgage rates for all of the lenders are sort of on the track, and a few of them have had to pull into the pits and having their tires changed and getting new bodies because they had a crash in this crisis, and we've never experienced that. As you remember, you've seen we've got significant cash resources on the sidelines, never having any kind of issues with a recap necessary for the company.

As I look out for the years ahead, it's a really interesting company, which, as Jeff said, we have all these gains in the investments we've made, and you'll soon learn about another gain that was opportunistic in a portfolio in the middle of the crisis with an unusual structure. Jeff referenced that securitization will take place this quarter. We have a funny company, which is resilient. The diversification of the business lines has proven to be a significant advantage.

And I think also that some of our business lines are still not performing at the appropriate stabilized earnings power, specifically our energy infrastructure business, which has kept a significant overhead while we pulled back from investing, and that continues to decrease its contribution to earnings given the scale that we hope to be at at this time, but obviously pauses for the energy markets went into a freefall. But as I mentioned, and Jeff mentioned, and Rina's mentioned, the book has held up extremely well with no margin calls and no deterioration in credit quality since in the entire period of the crisis. The other thing that's not obvious to shareholders is we don't, given the strength of our balance sheet, we never had to panic, and we held off selling loans, and particularly securities, including the loans that we held in our conduit, as well as RMBS.

We knew that they were mispriced in the crisis, and they were good credits, and so being able to hold on to those and sell them now with gains or tiny losses has been a great strength of the company, and we are cautiously going on offense, as Jeff said, and I'd say that we're trying to cherry-pick opportunities around the world. We recently committed to a deal in Europe, and we're looking at deals in the United States, but we do have to be careful. We're obviously in this period before the vaccine. We all hope the vaccine is successful. We also hope that people use it. We're realistic that they may not actually all use it, and so some of the sectors of the property markets, which have been injured the most, namely retail and hotels, we have to be very careful with.

But again, I think if you told me 10 years ago, when we started the company in 2009, I guess it's 11 years ago, that we'd be running a book 11 years into the process with a 61% LTV, I would be astonished, frankly. And the ability to continue to earn these kinds of returns in that position, the capital structure, or even the quality of the RMBS securities we're buying is truly something surprising, I suppose. It's been helped, obviously, by continued ease of availability of credit for our business, whether it's a CLO or warehouse lines or in-house sales, which match fund the maturity of our assets. And so we're quite blessed, I assume, with our scale and with a really super management team that's done a great job, all hands on deck, even if it's remote.

Everybody's been pitching in as we work through situations with borrowers and try to be creative and work through their issues that they've faced. It is an interesting time, but I'm really grateful for the enterprise that we've built and for the team that's been managing the company, but just quickly on the asset classes, obviously industrial has been fine. The housing markets are on fire. In some places, they're up dramatically. Multifamily is holding its own with small deteriorations in some markets and NOI. One of the things we're looking at is real estate taxes. As municipalities try to balance their budgets, significant pressure on real estate taxes, and we have to watch out for that. The office markets are relatively stable.

I recently was with a CEO of one of the major tech firms that announced that their employees will be working from home, and he said, "Well, not really. I mean, we just want people to know they don't have to come back to the office, but we prefer they come back to the office." So the media has kind of overdone that, I think. And people like us, we opened our New York office, we opened our Greenwich office, we opened our Miami office, and we're allowing people to come back to work, and a lot of them are choosing to do so. And then the hotel markets, as Jeff mentioned, extended stay is one thing, which we have a chain of extended stay hotels that we own in our equity book, which is running at 85% occupancy, which is up 200 basis points from pre-COVID.

But there are also hotels like a hotel we own, or actually we don't own, with a lender, on the first mortgage lender in Beverly Hills, where the owner has put in several $100 million of equity into an asset, and we've financed around $200 million in debt, and we never expect them to walk away from that property. So not all hotel loans are created equal, and that's our job, is to comb through the debris and find the deals we really think are great risk-reward for our shareholders. Retail is asset by asset. As you know, we own a portfolio of net lease Cabela's stores. They're corporately guaranteed. Cabela's is benefiting from COVID. Obviously, gun sales are up, and the credit quality is terrific, and I think we're in like a 13% cash on cash return on those assets. So with that, I'm going to stop.

We're going to take questions. I think one thing we're very much aware of is the coming maturity of our bonds in next step, but they can't be prepaid, as Jeff said, until November, so there's nothing we can do right now, except keep cash on hand if we have to, to do a smaller offering or find a different way to finance rollover. We can do the financing. It's not a question of that. It will be a question of what the coupon is. So we want to take the long road here, play long ball, and not sell assets that we think we have huge gains in just to sell them and create gains. That's why we're holding on to our multifamily book, because where else can we get 15% cash-on-cash yields that are increasing every quarter, frankly?

So we could sell them, but we would pay taxes, and we couldn't replace the duration of the cash flows. So with that, we'll all take questions. Thank you.

Operator (participant)

Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Steven Laws with Raymond James. Please proceed with your question.

Stephen Laws (Managing Director)

Hi, good morning. I guess first, it looks like you've made some new investments, obviously CRE, as well as the purchase of the non-agency loans that you covered that hasn't closed. Curious on the energy infrastructure lending. How do you feel about that portfolio and segment? I think a few weeks ago, you saw Hancock Whitney sell some energy loans. Was that something you guys looked at? Was there a read-through on that sale that makes you more positive or more negative on that asset class? Maybe talk about the outlook for the energy portfolio and any growth there.

Jeff Dimodica (President)

Hey, Steven, great question. Thank you for recognizing our new investments, and on the energy side, we were quiet this quarter. Spreads have certainly widened out. The banks have pulled back a bit. We think we can generate levered yields that are in excess of what we were generating before COVID. We actually approved a deal just a couple of weeks ago that we didn't end up buying. We thought we could potentially buy a little bit cheaper secondary, and that didn't quite work out. I have Sean Murdock and Denise Tait on the line with me, and regarding your question on the portfolio and what they're seeing specifically there, why don't I turn it to Sean and Denise to quickly give you an update?

Barry Sternlicht (Chairman and CEO)

Sure. I think we're seeing the markets in energy stabilize. It sort of finds its footing after COVID, and our portfolio of potential investment opportunities are growing. And as Jeff said, they're at attractive returns versus the returns we were generating pre-COVID. I'd add that Jeff mentioned we're working hard on doing a CLO, which we think sort of proves out the business model in terms of generating term non-recourse financing for our loan activities.

Stephen Laws (Managing Director)

Okay. Great. So looking at.

Rina Paniry (CFO)

Sorry. It's Denise. Just to add on the Hancock deal, those deals were all oil and gas drilling deals and service deals. So we're not investing close to the wellhead, which is what those deals are. So they have a lot of commodity risk associated with those deals, so not really a good comp for our book.

Stephen Laws (Managing Director)

Okay. That's helpful. Thank you for that.

Jeff Dimodica (President)

Steven, finally, we probably need 15 or so new investments to complete our portfolio for the CLO that Sean and I have now both talked about. Our goal over the next six to nine months will be to get to the point where we can accretively come with a CLO to move this debt off balance sheet.

Stephen Laws (Managing Director)

Great. And then, Barry, question on the election. If the date holds, your next conference call will take place the morning after the presidential election, and I guess depending on mail-in votes in different states, we may or may not have an answer of who the next president is. Can you talk a little bit about - I know you've got the new investments you're doing. You've got a very strong balance sheet. You mentioned maybe raising some debt around some maturities later this year. Let's go in November election as well. The risk, if Biden's elected, regarding the real estate taxes he's proposed, eliminating like-kind exchange, how does that - the different things I'm sure you're aware of - how does that impact how you think about Starwood, the mortgage rate, and then bigger, just how you think about real estate investing in general if that were to come to fruition?

Barry Sternlicht (Chairman and CEO)

Yeah. I think the most important thing we look at is rates, and there's no yield in the world. Underpinning real estate, there's tremendous, rates are too wide. I think I was reading something where we mentioned Amazon Lease Credit will trade at a 5% cap rate, and their bonds trade at like 40 basis points or something like that. There's a huge premium on real estate yields because people perceive, I think, weakness in the income streams, which is not only, you can't really invest macro. You have to invest micro, and you have to go block by block, and you can look at the credit quality of a cash flow stream. So I think if you think that Biden's election will decelerate the economy, whatever that means, given we have a minus 32% on GDP, I think there'll be no issue. Rates will stay low.

I don't think, for example, the like-kind exchange is relevant to the kinds of assets we finance. I think it's mostly used by individuals buying strip centers and franchise net-leased assets. Again, because there's no alternative, will they sell it seven caps instead of six caps because their tax? The like-kind exchange thinking should go away. It isn't required. It isn't helpful, and it's unique to real estate. So that's an easy loophole for them to fill. I've never used it in my life, by the way, so I've never been affected by this. But I think other situations, other issues like municipalities taxing real estate is a double-edged sword.

Reducing the volume or the value of buildings in cities because they're doubling property taxes means the capital won't flow into those cities to either build a new building or to buy a building if you think values are going down. So while it seems to be a popular thing to tax buildings assuming that wealthy people own them, the truth is obviously shareholders own them in the public market. I assume some of those are pension plans and individuals, and the truth is they're not going to create. There are certain families that own buildings, but they're the minority of the U.S. property market. So there's certainly more wealth in tax. Go tax tech and talk to me later. So the real estate markets, I think, are also. They're not pricing in inflation.

It's interesting to me with gold past $2,000 and Bitcoin rallying that hard assets haven't really gotten a bid globally. I think that will change. I think people will begin once you feel like there's, I describe this climate as walking in quicksand. We think the ground is stable, but it shifts. We don't know if there'll be a vaccine around election. In January, will it work? Will there be somebody that comes out with a vaccine that doesn't work? People get pissed off. Walmart, Novartis, and AstraZeneca produce their vaccines later, which presumably will be more institutional, if you will. It's a choppy road, and we have to be careful. We're here for the long haul. We're not here to have a one quarter.

I didn't mention. I should have mentioned that I have in my notes that you're sitting on $800 million of cash, or even $600 million of excess cash at 10% yield, which we've obviously done better in all our business lines than that. It's $60 million. It's $0.20 a share in earnings, so you can add $0.20 to our earnings for a normal period for us once we put the capital to work, but we can't do that. However, we can cover the dividend because we have all these beans in our books, and so that's kind of an interesting time. It's a scratch your head a little bit, but be careful, and I think the election is not over yet, and I don't think generically. I think the move to increase all taxes: corporate income taxes, capital gains tax, as well as tax on the wealthy. We'll see. It's a complicated puzzle.

Will they change depreciation schedules for real estate? I don't know. Usually, hard assets are held for long periods of time, and people like to use them as inflation hedges. I do think capital gains tax changes will mean people will hold assets longer. So there'll be less for sale, most likely, especially from taxable institutions or individuals, not necessarily pension plans. So the long answer is I have no idea. I can argue both cases.

Operator (participant)

Thank you. Our next question comes from Rick Shane with JPMorgan. Please proceed with your question.

Rick Shane (Managing Director and Equity Research Analyst)

Hey, guys. Thanks for taking my questions this morning. Jeff, you'd spoken about the purchase of the low loan-to-value Resi portfolio and the possibility of securitizing that above par. How should we think of that from an economic contribution? And if you do the securitization, is that a gain that you recognize, or would that discount continue to be accreted into income going forward?

Jeff Dimodica (President)

Yeah. Thanks, Rick. Good question. These purchases, we were fortunate during COVID to be able to buy them at a discount, as you just said. The securitizations today are above par. I think single Bs are trading on any yield that are about equivalent to the gross WACC, the coupon of the underlying pools. So these are obviously very accretive when we can sell AAAs at 120 over or whatever that is. So the financing markets have come roaring back. And I think one of the reasons is there's going to be a lot less supply in the coming months. The non-QM originators will be doing less volume. People have cleaned out most of the loans that they have.

So given there are a lot of bond buyers who really like this sector, and they like it because of the strong credit characteristics that we like it for, the reality is that securitization pricing should continue to be pretty strong going forward and will increase the whole loan bids to significantly above where we purchased stuff. As far as the gain goes, these gains are taxable, so we will have some tax issues. There are hedges in these, and given what rates have done, there'll probably be some small hedge losses, but net of all of that, there should be very large gains that we will likely take along with that at the times of the securitization, so as we head into the next couple of securitizations, I think you'll likely see some fairly large gains along with that as opposed to just running it all through coupon.

Rina, do you have anything different you would say there?

Rina Paniry (CFO)

No, I would just say that it's consistent with how we've treated the past securitizations in this business as well as our conduit Starwood Mortgage Capital. So we recognize the gain at securitization.

Rick Shane (Managing Director and Equity Research Analyst)

Great. Perfect. Thanks, guys.

Operator (participant)

Thank you. Our next question comes from Tim Hayes with B. Riley FBR. Please proceed with your question.

Tim Hayes (Research Analyst)

Hey, good morning, guys. Hope you're all doing well. My first question, just on the CRE pipeline, can you maybe size that for us today and just give us a little bit more color on the characteristics? It seems like you're migrating towards higher quality, more stabilized assets. So are you seeing yields come in a bit there or spreads come in a bit there and LTVs move up? Or just curious, maybe you can talk about the assets also that or asset types you're focusing on.

Jeff Dimodica (President)

Yeah, sure. It's Jeff. I'll start, and I'm sure Barry might jump in. And Dennis Hu, our head of originations, is on the line. I would say immediately post-COVID, the handful of opportunities that we saw were significantly wider. You've seen some spread tightening here as people are coming back into the market. A lot of our competitors are not looking to invest today. So there is a little bit better opportunity set for us to get into some things that we couldn't necessarily get to our rates of return on pre-COVID. I think we're seeing a decent amount of multifamily that we really like. We're seeing industrial that we really like.

We're seeing sectors that we want to be in with the ability to potentially sell A-notes or use them as CLO collateral as opposed to continuing to add to warehouse lines, which, as you know, are less than half of our financing of our CRE book and the lowest, I think, among our peers. So we will continue to sort of look to keep less to bring on assets with less future funding. I think given the uncertainty around repayments, and we've pushed out cautiously, we've pushed out repayments significantly into the future. Right now, we'd like to have less future funding than more future funding obligations until we have a little bit more clarity about how we get repaid.

So I think you'll see us stick to our knitting with some fairly conservative product types and probably not doing much, if anything, in retail, which we haven't done in the last few years or other sectors that could be considered a little bit more volatile. Barry, do you have any thoughts or Dennis that are different?

Barry Sternlicht (Chairman and CEO)

I'll say our loans are chunky, right? I mean, we're doing bigger loans, obviously, than maybe some of our smaller peers. There's patience in the deck. I mean, we invest $400 million in the back half of the year. It's like 4% to 5% earnings. It's not going to make or break our year. If we can get a 15-month cap, we have to put out a third less to get a 10 that we're running our model on, even though our loans are doing better than that. The energy book is well north of the returns we can get in real estate right now. The one problem that I see for lenders is the volume of deals.

Until sort of the dam breaks here, where people really run out of extensions and collaboration the banks are doing, they don't really have to sell, and they don't want to sell. Nobody wants to sell pre the end of COVID. So transaction volumes globally are down. That means financing opportunities are down. And yet, I think people perceive that there will be light at the end of the tunnel. So as Jeff mentioned, spreads have come in. There have been a few, I don't know if you'd call them CLO financings, for a few people who are peers. And even though the spreads have come in, they're being bid heavily, dramatically. It's interesting because, obviously, we did one of them, and there's trouble with them, they're being rerun now. It's interesting to see where the pricing is. You're seeing a lot of hedge fund participants at that market.

They're, I would call it, less grounded up and a little less. I've done this for so long that sometimes we've seen these assets trade three times in, seem like, 30 years of doing real estate. So I mean, I feel like we know these assets, and somebody who's new to the business just wouldn't have a perspective in why that asset, even though it looks like it's in a good location, has never worked. So we just try to avoid the landmines. And there were opportunities. Construction itself is going to drop dramatically. It's already dropping. I think multifamily will be down 100,000 units from peak. And I don't see a lot of people starting anything spec, and office. Hotels will finish their construction pipeline that's actually too large. And then I think you'll see a tremendous reduction in supply.

I think the two areas where demand isn't going to return to the levels it was any time pre-COVID will be hotels and retail. Those are the two asset classes that it's tough because you could get extraordinary deals, extraordinary spreads in those asset classes. But you're going to have to predict a future that's not going to look like 2019. Not for a while. I mean, there's no question business travel will be injured for some period of time until air traffic's restored and international travel comes back. So their underwriting is going to be different than the underwriting we had before. And we're competitive as heck, so we look at. There's a deal that doesn't go by through the shop. I don't see that. We see that. What do we think? I think Jeff and Denise can support that.

But there's a lot of stuff we'll pass on right now. This was risk-reward, like, "Why do I take the risk?" And we do. We can survive just that we have a really strong, we'll probably survive as well as anyone can in this space. Having said that, if the COVID went on four years, it's going to be tough. So I think it's tough for the equity markets too, by the way.

Jeff Dimodica (President)

I personally would like to thank Walmart, Barry, and subscriptions to all the new services that show them every deal that gets done because we do get a question on all of them. To finish that up, I would say our pipeline today is about two pages long, almost two full pages, which is almost similar to where we were pre-COVID. It started out very small. We have eight loans or so in the red zone that would use a decent chunk of our budget at returns that are above what we've seen.

I would say also when the street originates a loan and then they try to sell a mezzanine, something that we do very little of. We've seen two deals that we actually liked the credit on, but they thought they could sell the mezzanine 300 basis points or so inside of where we would bid, which is why we like to create our own cookbook and underwrite and originate our own loans and then sell off our seniors ourselves. The bid from hedge funds and others who don't have the origination capability is back, and it's voracious, and it's causing those mezzanines that are originated by the street to trade multiple hundreds of basis points inside of where we would begin to care. Sorry for the long answer, Tim.

Zack Tanenbaum (Director of Investor Relations)

Jeff, Denise, I'd say generically returns are up about 200 basis points versus pre-COVID levels. And I'd say generically leverage on the asset classes that we want to be lending on are probably down about five points on average. That's just generic. But as Barry said, it's deal by deal, asset by asset, street by street, so.

Tim Hayes (Research Analyst)

Yeah. No, I appreciate the detailed response there. That was a lot of good information, so I appreciate that. And then just on the margin call holidays you have in place on the hotel loan portfolio, can you just remind me when those were put in place and the duration of those agreements? And just curious if it's too early to begin having conversations about extending those and what it would take, whether it's just additional deleveraging or other kind of give-ups that would be needed if you wanted to extend those agreements.

Jeff Dimodica (President)

Yeah. Thanks for the question. I would say in general, they expire around year-end this year. We're certainly hoping that hotels start to see a little bit better performance come year-end. In general, the deleveraging was somewhere in the 10% area. My guess is if year-end comes and things are still not great, that you potentially have another small deleveraging, but a fraction of the 10% that we paid down previously, which was only $100 million in total across those. So not a huge liquidity scare for us, but sort of hoping that hotel numbers come back a little bit into Q4 and that we're able to hold the line. The bank lines, generically, if we're writing a 65 LTV loan or something like that, the banks are lending to us at 45 LTV on these assets.

So if we've already paid them down by 10%, at some point, it becomes a sort of ridiculously low leverage level from the seniors. So the next round will be very small, is my hope.

Tim Hayes (Research Analyst)

Got it. Okay, and then just my last one here, circling back on the dividend. I know it sounds like investment activity should pick up a little bit on your guys' end in the second half of the year. A lot of good opportunities for capital work, but also sounds like your elevated cash levels aren't going anywhere, so just wanted to circle back and see how, I know it's a board decision, but how you're thinking about continuing to under-earn the dividend for the foreseeable future, just knowing that you could earn it if you wanted, but that might not be the near-term pipeline.

Barry Sternlicht (Chairman and CEO)

Can we say no comment? Again, I'm a big shareholder myself. I'd love to maintain the dividend. And the market doesn't think we're going to maintain the dividends. I think the street has us paying $1.60, I'm told. So in the stock trades, it's a ridiculous yield, so given what's going on and the discounts of our peers. So it's really. And there's plenty of competitors that actually aren't paying any dividend. Their stocks are holding up. So we're going to just look at it month by month. And at the moment, we've obviously held our dividend. But I think my comments would infer to you is we can't cover the dividend. We just want the world to be normal or look like it can get to normal sometime soon. So I think we'll leave it at that.

Operator (participant)

Thank you. Our next question comes from George Bahamondes with Deutsche Bank. Please proceed with your question.

George Bahamondes (Equity Research)

Hi. Good morning. You cited roughly 11 loans bonafide during the quarter. I imagine the majority of these loans were hotel or retail. I wanted to confirm if that was accurate, and secondly, if maybe there were some other loans that were not hotel or retail, just kind of giving some more context around the mix there.

Jeff Dimodica (President)

Yeah. The vast majority was hotel, as you supposed. That's absolutely correct. The others are some very small, some very small, mostly technical modifications that have been done to date. But the majority of the mods have been on hotel book.

George Bahamondes (Equity Research)

Great. And my second question, and this is detailed. You talked about good news money for unfunded commitments. Can you just revisit those comments on how much of the $2 billion is callable or maybe it's going to be dependent on some sort of performance milestone?

Jeff Dimodica (President)

How much of the $2 billion is callable? I'm not sure I understand exactly if you can.

George Bahamondes (Equity Research)

or even good news, right? So it's going to be dependent on some sort of leasing activity.

Jeff Dimodica (President)

How deep inside? Yep.

George Bahamondes (Equity Research)

Right. Or just kind of any sort of performance milestone. Just wondering how much of the $2 billion is maybe tied to that.

Jeff Dimodica (President)

Yeah. I said in my comments, I believe about a third of it typically is good news money, and about two-thirds is future draws on construction. And the $2 billion is gross. I would assume that none of our banks fund alongside of us, and we always assume that our banks will fund alongside of us and leave us less than $1 billion of net future fundings from us. So using that same math, $333 million if it were exactly $1 billion of good news money and $600 million repayments.

Operator (participant)

Thank you. Our next question comes from the line of Donald Fandetti with Wells Fargo. Please proceed with your question.

Donald Fandetti (Managing Director)

Yeah. Barry, there's some bearish views on New York office. You had commented a little bit about the tech CEO that you spoke to, maybe implying it was somewhat overdone. Can you provide your thoughts on New York office and kind of where you think will be a year or two from now?

Barry Sternlicht (Chairman and CEO)

Yeah. I do think the big blue cities are facing some troubles, and the pressures on real estate taxes on office properties will be tremendous because they're big. You can still tax them. You can't tax street-level retail, and hotels are closed. So I think it's not even so much rents fall, so much as expenses going up. Rents have to go up to meet the increase in expenses. For a while, as you know, the way leases are structured, the tenants will pay those increases. But when the lease rolls, it will be, and sometimes the lease is written so that the landlord has to absorb the increase in taxes. I think you're seeing interesting issues emerging in some office markets, mainly San Francisco and New York. San Francisco, nearly 10% of the space in downtown is now up for sublet.

So I think you're going to see a significant decrease in rents in San Francisco. Being the heart of techland and the fact that the downtown San Francisco is less clean and has issues right now, I think people are thinking they can go somewhere else and work in the suburbs. And so the CBD has some issues. I think in New York City, it's funny. I got a lot of criticism for saying rents would be down in New York. Rents will be down in New York. They're already down in New York. But I do think people want to work from their offices. And what I was really referring to wasn't actually COVID or even the protests, some of which turned into riots.

I think there's a general perception that the city is unsafe, and nothing will clean out a downtown faster than a return to mayhem in urban markets. And whether it's downtown Atlanta or downtown Washington or downtown New York or Chicago, I think the city mayors are going to have to pay attention to the one thing about safety. And safety, you can't price into real estate. So it's really important that these cities get control of the safety issues. And if people feel like their children aren't safe, they're going to move. And across the country, this flight to suburbia is taking place, which is kind of fascinating. It's not exactly what you might expect. Another thing that's not going to disappear, all we're doing is fighting that on the margin with the pressure on rents up or down.

In the middle of COVID, as I pointed out, Facebook and Cornell just announced it took a 730,000 sq ft lease in the Farley building, and I'm aware of Facebook taking space in a building in Portugal, and another 400,000 sq ft deal was just signed in Boston. So deals are getting signed. It's pretty hard to sign a lease when you can't visit the property, and most CEOs are sort of taking a time out and trying to figure out what the future looks like. Small tech firms, they're always distributed in the way they ran these companies. So a program can sit in a cave in Alaska and do its work. Most companies don't work like that, and I think as I talked to that tech CEO, I asked about loyalty. I mean, how do you build a corporate culture?

And then how do you deal with people who don't have Wi-Fi at home and others who don't have the kinds of connectivity that wealthier people have? So as my friend Tony Malkin said recently, it's a little discriminatory to force everyone to work from home. So obviously, service industries, you can't do that anyway. So I think New York's in trouble. I'm going to blame it on the administration of the city right now and the city council much more than New Yorkers are horribly resilient and tough. But I think safety means people don't want to go back to open markets. And that's something that the city's chapter is not written yet on. And I think other cities will benefit from this.

Whether it's Nashville or Austin, Texas, or Dallas, Houston, the Florida capitals, Tampa, Orlando, Miami, Jacksonville, Georgia, there are places benefiting from this kind of cloud coming over these larger cities. Boston's probably fine, by the way. But there are other issues in other cities. It will affect property values. That's something we have to watch out for.

Jeff Dimodica (President)

And Don, I will say, and Barry has pushed us this way for a long time, but less than 3% of our loan portfolio is Manhattan office. It's three loans. Two of them are small, and we expect to be pretty soon, and one is on a diversified portfolio, including a large investment-grade tenant taking the bulk of it. We feel really good about those three loans. But again, very small percentage of our portfolio in Manhattan office.

Operator (participant)

Thank you. Ladies and gentlemen, our last question for today will come from the line of Jade Rahmani with KBW. Please proceed with your question.

Jade Rahmani (Managing Director and Equity Research Analysy)

Thank you very much. I get a lot of questions on Starwood's New York City exposure, and I was wondering if you could quantify that and also provide some commentary as to the few specific loans that are in the New York market and how they might be positioned in terms of future credit performance?

Jeff Dimodica (President)

Great, Jade. Thanks for the question. In total, including all New York City area, our exposure is about 14% of the loan book today. About 37% of that is office. There are condos in there, and these condos have significantly low bases. You and I have talked about a few of them in the past, and we feel very good about the condos. I would say, as I look across our portfolio, we do have the one condo that we have spoken about before that we have taken a reserve on. So away from that, the rest of that condo book feels pretty good. We still have a recourse guarantee on that, and it is still in the process of selling units. So we believe we'll be done in the next 12-15 months with that loan, again, with full recourse. And.

Barry Sternlicht (Chairman and CEO)

Jeff, it's Barry. I'm just interrupting you. Can you reconcile the 3% you said was in New York in your first comment, last question, the 14% you said it was in New York and on the runs?

Jade Rahmani (Managing Director and Equity Research Analysy)

Yes, sir.

Barry Sternlicht (Chairman and CEO)

Answer the Jade question.

Jeff Dimodica (President)

Absolutely. So we're about 5% of our book in total is office. 60% or 3% of that or so is in Manhattan, and the rest is in, as I look here, Brooklyn and Long Island. So about 5% of our portfolio is office out of, and then 14% of our portfolio includes all New York City office, condo, hotel, and multifamily, Barry. Our one hotel loan is only $36 million in the.

Barry Sternlicht (Chairman and CEO)

The asset base is north of $17 billion, and our loan book is $9.4 billion. So keep that in mind too.

Jade Rahmani (Managing Director and Equity Research Analysy)

Great. Thanks for taking the questions. And then just in terms of the overall loan portfolio, given the recent A-note sales, what percentage of the loan portfolio is B-note at this point?

Jeff Dimodica (President)

I don't have that exact number. I want to make sure we can give you an exact number. I think we're about 45% today on bank lines, and we obviously have the large CLO, and the rest would effectively be B-note. But I don't have it on the tip of my tongue, Rina, unless you have it. Jade, we can come back to you with the exact number for percentage B-note.

Operator (participant)

I do not. I will come back to you.

Barry Sternlicht (Chairman and CEO)

I just point out again that you have a warehouse line on the RMBS and FHLB line, and you have a different set of lines on the energy book. So we're not just talking about real estate anymore or CRE real estate.

Andrew Sossen (COO)

Hey, Jade, it's Andrew. Out of around $9.4 billion in the commercial lending book, there's about, call it $600 million of Mez and about $150-$160 million of preferred equity. So call it around $750 million out of $9.4 billion. And that's carrying value of the assets.

Jeff Dimodica (President)

Andrew, I think he's also considering things where we sold an A-note, so I think we should get back to him with the exact number that includes that.

Jade Rahmani (Managing Director and Equity Research Analysy)

Thank you very much. I'll follow up on that later.

Operator (participant)

Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Sternlicht for any final comments.

Barry Sternlicht (Chairman and CEO)

Thanks, operator, and thanks for your questions and for joining us today. The one thing I'd say is I am very proud of the fact that we've won this award, New York Ultra Award, for seven years in a row, and everyone publicly said we treat our shareholders like our partners, and we do. So we're available to answer your questions, and the team has always been available to do so. So without giving away things we consider proprietary, we want you to understand what we're doing and the risks in the book, and we appreciate you spending the time with us and supporting us. Thanks. Have a great holiday, whatever this is, summer, August. Take care.

Operator (participant)

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.