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Edited Transcript of STWD earnings conference call or presentation 7-Aug-19 2:00pm GMT

Q2 2019 Starwood Property Trust Inc Earnings Call

GREENWICH Aug 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Starwood Property Trust Inc earnings conference call or presentation Wednesday, August 7, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Jay Sossen

Starwood Property Trust, Inc. - COO, General Counsel, Chief Compliance Officer, Executive VP & Secretary

* Barry Stuart Sternlicht

Starwood Property Trust, Inc. - Chairman & CEO

* Jeffrey F. DiModica

Starwood Property Trust, Inc. - President & MD

* Rina Paniry

Starwood Property Trust, Inc. - CFO, Treasurer & CAO

* Zachary Tanenbaum

Starwood Property Trust, Inc. - Director of IR

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Conference Call Participants

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* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Jade Joseph Rahmani

Keefe, Bruyette, & Woods, Inc., Research Division - Director

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Starwood Property Trust Second Quarter 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Zach Tanenbaum, Director of Investor Relations for Starwood Property Trust. Thank you. You may begin.

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Zachary Tanenbaum, Starwood Property Trust, Inc. - Director of IR [2]

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Thank you, operator. Good morning, and welcome to Starwood Property Trust's Earnings Call. This morning, the company released its financial results for the quarter ended June 30, 2019, filed its Form 10-Q with the Securities and Exchange Commission and posted its earning supplement to its website. These document 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 on 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'll refer you the company's filings made with the SEC for a more detailed discussion of the risk 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 in this conference call. Our presentation of this information is not intended to be considered in isolation or a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.

Joining me on the call today are Barry Sternlicht, the company's Chief Executive Officer; 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'm now going to turn the call over to Rina.

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Rina Paniry, Starwood Property Trust, Inc. - CFO, Treasurer & CAO [3]

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Thank you, Zach, and good morning, everyone. We reported core earnings of $154 million or $0.52 per share for the second quarter. Our performance was led by our largest segment, the Commercial and Residential Lending segment, which contributed core earnings of $125 million to the quarter.

On the commercial lending side, we originated $1.1 billion of loans with an average loan size of $109 million.

As we continue to expand our international footprint, 19% of these originations were outside the U.S., including our first loan in Australia, for $153 million.

During the quarter, and consistent with our expectations, we received $763 million from repayments and $103 million for May Note sales. These info slightly outpaced funding of $496 million on new loans and $216 million on pre-existing loan commitments.

Our commercial loan portfolio ended the quarter at $8.1 billion with a weighted average LTV of just under 65%. As a reminder, we update the LTVs on our loan book at least once a year, or more frequently as information becomes available.

Our loan book continues to be positively correlated to both rising and falling interest rates. With 94% of our commercial portfolio being floating rate. We estimate that a 200 basis point increase in LIBOR would add $0.11 of core earnings annually, while a 200 basis points decrease would add $0.12. We are positively correlated to declining rates because of LIBOR floors, which we have on most of our commercial loans.

On the residential lending side, we continued our expansion of this business by purchasing $501 million of non-QM loans during the quarter. At quarter end, this loan book totaled $1.2 billion, with a weighted average coupon of 6.1%, an average LTV of 66% and an average FICO of 730. Including retained securities of $63 million, the net equity of this business totaled $536 million. Just after quarter end, we contributed loans with an unpaid principal balance of $546 million into our fourth successful securitization.

I will now turn to our Infrastructure Lending segment, which contributed core earnings of $2 million to the quarter. This includes a $3 million loss on extinguishment of debt resulting from the sale and repayment of loans that we acquired from GE.

As you know, our strategy has been to solve a lower-margin loans in this book and redeploy the capital into higher-yielding loans. As we execute on this strategy, we sold $171 million (sic) [$174 million] of the GE loans this quarter. We also received prepayments of $77 million, bringing the balance of the acquired portfolio to $1.3 billion (sic) [$1.6 billion]. The remaining $350 million of infrastructure loans on our balance sheet were acquired post-acquisition. Our purchases were lower during the quarter while we work to complete a $500 million debt facility which has better match term financing than our existing lines. The facility closed in July, and we expect production to increase to a more normalized level in the second half of Q3.

I will now turn to our Property segment, which contributed core earnings of $30 million to the quarter. The performance of our Florida affordable housing portfolio continues to vastly exceed our expectation. Area median income level, which govern rent for the over 15,000 units in this portfolio were recently released. Higher median income for Northern and Central Florida, where this portfolio is concentrated, resulted in a blended rent increase of just over 6%. These rents create a new floor which cannot decrease going forward. The increases became effective on June 1, so you will see the full effect on earnings on Q3.

All of the wholly-owned assets in this segment continue to perform well with blended cash on cash yields increasing to 13.2% this quarter and weighted average occupancy remaining steady at 97%.

As a reminder, these assets are financed with debt containing an average remaining duration of 8.5 years at a weighted average fixed rate of 3.8%.

As of quarter end, these properties, along with those in our Investing and Servicing Segment, carried accumulated depreciation of $348 million or $1.24 per share. While we've said it before, we think it bears repeating. The appreciation of these assets is not reflected in our GAAP book value. At a minimum, adding back $348 million to our GAAP book value would arrive at our purchase price for these assets. The gains that we believe exist in this portfolio would be an incremental add back to book value.

I will now turn to our Investing and Servicing Segment, which contributed core earnings of $48 million to the quarter. This business continues to utilize its various cylinders to produce a stable return. In our conduit, we securitized $345 million of loans in 3 transactions this quarter. In our servicer, we saw lower income levels than last quarter due to the continued runoff of CMBS 1.0 loans. As these legacy 1.0 deals resolve, we continue adding new CMBS 2.0 servicing assignments.

Over the last 12 months, we have added 28 CMBS 2.0 deals to our named servicer portfolio with a principal balance of $18 billion, including over $4 billion just this quarter.

I will conclude my remarks with a few comments about our capitalization and dividend. During the quarter, we extended 2 of our existing repo lines by a total of $950 million. These amendments provided an additional $700 million of financing for our Commercial Lending business, as well as $250 million of short-term financing for any loans targeted for securitization.

After quarter end, we continue to optimize our capital structure and expand our refinancing option. In July, we completed a $400 million, 7-year Term Loan B, which priced at LIBOR plus 250 basis points and 25 basis points of original issue discount. The proceeds were used in part to repay our $300 million Term Loan A. We also entered into a $100 million revolving credit facility to replace our current revolver.

And finally, we priced our inaugural CRE CLO, which Jeff will discuss with you in more detail. These financing alternatives, along with the $767 million in loan commitments that we sold in the first 6 months of the year, continue to strengthen our balance sheet and reduce our reliance on bank lines.

We ended the quarter with an ample $6.5 billion of undrawn debt capacity and an adjusted debt depreciated -- undepreciated equity ratio of 2.1x, which was flat last quarter.

And finally, for the third quarter of 2019, we have declared a $0.48 per share dividend, which will be paid on October 15 to shareholders of record on September 30. This represents an 8.3% annualized dividend yield on yesterday's closing share price of $23.01.

With that, I'll turn the call over to Jeff for his comments.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [4]

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Thanks, Rina. Our company is 10 years old this week, and although many things have changed, we have done what we set out to do, create a generational vehicle by taking advantage of mid-priced sectors to create business lines that finance and own the most stable assets, finance the most diverse and safe liability structures available to us.

We spoke on the earlier calls about the stress test we ran our business following the 15% stock market sell-off in December 2018. Although we had ample liquidity to withstand the large moves we tested for, 20% lower on all real estate values and 250 basis points wider on all security spreads, we decided at the time to redouble our efforts to create the most diverse and stable right side of the balance sheet in our industry in 2019.

Given the market volatility of the last week, we're happy to say that we've made tremendous progress diversifying and derisking the right side of our balance sheet this year.

We have never originated loans assuming that CRE CLO exit. Securitization markets can be fickle, spreads can move quickly and the CLO exit is not always accretive. For the same reason, and despite our financing advantage, we have not chosen to invest in CLO senior bonds, which require tremendous leverage with repo spread markets to earn a modest return, have significant spread volatility and can often be illiquid to sell in the secondary market.

That said, CRE CLO financing levels have followed credit and corporate CLO spreads tighter this year. And more importantly, their structures have improved dramatically in the issuer's favor.

On July 26, we priced the largest postcrisis CRE CLO to date, $1.1 billion, which we'll settle on August 15. We priced the largest, most issuer-friendly structure at the lowest cost of funds and highest advanced rate to date.

Our CLO also produced incremental unencumbered assets for us and eliminated the recourse and credit marks they have on bank warehouse lines while increasing returns by over 300 basis points on the underlying loans.

I'd like to thank our incredible staff for completing what is normally a 12- to 14-week process for a first-time CLO issuer to get to market and pricing in just over 7 weeks, in order to avoid the potential credit spread and rate volatility that is so common for August and we are seeing this week.

Our dedicated capital markets team has always been a most active seller of A Notes in our industry, completing over $8 billion in sales since our inception. A Note sales are perfectly matched term financing and are more expensive than bank warehouse facilities, but have the advantage of being off balance sheet term financing without the recourse, credit marks or across, against other assets that make bank warehouse lines the cheapest but least structurally efficient means of borrowing for us.

In Q1, we replaced $654 million of committed warehouse borrowings with A Note sales and expect to close this month on an additional $674 million that we will move off warehouse lines, as we did the collateral in the CLO. These A Note sales on seasoned loans where our borrowers' executing their business plans are at level similar to our bank warehouse lines, and therefore, do not materially affect our return.

Our industry has relied primarily on warehouse line financing to hit their return target. While we issued unsecured debt at LIBOR plus 128 in 2018, many of our peers use the CRE-CLO market to add a -- to diversify away from their reliance on bank warehouse lines, or to create room on their warehouse lines.

None of our peers have aggressively sold A Notes to date, and only one other has created an unsecured debt ladder. I will leave it to the analysts on this call to give you a more exact number, but our peers generally have 2/3 or more of their secured borrowings on warehouse lines today.

Upon closing of our CLO and the A Note sales we have signed up, we expect to be a significant outlier to the positive side with just 36% of our large loan CRE lending book financed via warehouse lines and over $5 billion in warehouse line capacity available to us today.

Rina spoke about the 7-year Term Loan B reprice subsequent to quarter end at LIBOR plus 250, which was not only accretive long-term financing but also created unencumbered assets. As a result of the actions we have taken this year and expect to close in the upcoming weeks, we expect to have $3.4 billion of unencumbered assets on our balance sheet to support the $2.15 billion of unsecured bonds we have outstanding today, giving us tremendous flexibility to issue more unsecured debt in the future.

We set out 5 years ago, on our goal to eventually become an investment grade rated unsecured bond issuer, allowing us to borrow at lower rates and earn higher returns. To that extent, we have diversified our investment cylinder, added over $3.5 billion in real property, created unencumbered assets to support issuing unsecured bonds and kept our leverage significantly lower than our peers, all things we believe will lead rating agencies to look at us differently than mono-line mortgage REITs.

We are delighted to have made so much progress this year in strengthening the right side of our balance sheet, increasing our returns and significantly reducing potential liabilities. These actions require tremendous effort and dedication to a long-term business plan, and we believe the results will be apparent, should the credit markets fall during the future.

In our CRE lending books, spreads are certainly tighter than a year ago, but spread tightening is moderated in the recent rate rally and our cost of funds has continually improved, allowing us to continue to earn similar risk-adjusted returns.

Continuing our credit first mentality and very steady run rate, we, again, closed over $1 billion of loans in the quarter and have a similar pipeline signed up for Q3 at similar optimal leveled -- levered returns.

We continue to see some of our best lending opportunities internationally, and after dipping to just 8% of our lending book in 2018, our book is 16% international today. And given our pipeline, we expect that number to continue to grow.

Our manager, Starwood Capital Group, have added employees in both Europe and Australia, where we closed our first loan last quarter to take advantage of what we think is a terrific opportunity today.

Rina mentioned that our company will, for the first time, make more in the 200 basis point decline in rates than in the 200 basis point increase. Our focus on structuring loans, including LIBOR floors that are at or near current rates, is a big driver in this expected outperformance and will create excess earnings regardless of whether LIBOR rises or falls.

Our price-to-book ratio today of 1.4x is near its highs, and we continue to urge analysts and shareholders to net out depreciation and gains when computing ours. Our Q2 book value of $16.48 per share is understated by $1.24 per share due to depreciation, net of which our book value would be $17.73 per share.

Our Property portfolio is performing exceedingly well, due mostly due to the massive outperformance of our 99%-occupied Florida multifamily portfolios in the past year that Rina mentioned.

We believe we have over $700 million in gains or $2.50 per share, not currently reflected on the balance sheet. Depreciation and property gains significantly underestimate -- under state our book value, which net of these items would be over $20 per share. At $20 per share adjusted book value, our stock is trading well below our historic average, despite being the best performer in our sector this year.

We've spoken about taking gains in a portion of our property book and expect to later this year. We also have the opportunity to refinance properties that have performed exceptionally well and expect to lower our cost of funds, increase our cash returns and take out an additional $180 million of cash in refi, scheduled for later this year. Deployment of gains and cash out refi proceeds will add to earnings as we reinvest them into new assets in the coming quarters and years.

We believe that our consistency, multi-cylinder investment engine, large property gains and differentiated balance sheet put us in position to continue to outperform for the remainder of the year and beyond, regardless of market cycle or direction of rates. I've gone on for longer than usual today, and since Rina discussed non-QM, REITs and debt, I will leave the follow-up -- I'll leave that to follow-up in the Q&A. With that, I will turn the call to Barry.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [5]

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Thanks, Jeff, Andrew, Zach and Rina, and good morning, everyone. I'm sure you're looking at your quote machines, and wondering what's going on in this chaotic of world.

It is a troubling time, and for real estate, we have to make calls on the direction of property values since we lend across the sectors, across the world. What -- interestingly, I mean, real estate is a yield vehicle, happens to be, I can't buy anything at an A cap other than our own stock. But the drift of lower rates is obviously good for Property as the world is starved for yields. And it looks like, particularly in Europe, you're not going to see any turnaround in cap rates anytime soon, and you'll probably will see cap rates continue to drift down.

Lenders like us are likely to see our LTVs move down as property values increase and further emphasizing the quality of the book and the security of our lending practices. It's tricky to lend in these markets because the cap rates feel a little artificial, but so does printing endless paper by Western governments that no country has any hope of ever repaying.

So I do think the property sector is an awfully good place to hang your hat right now, and if you're in the lending side, you obviously aren't taking the equity risk. You're just hoping that they'll pay you the capital you have, whether it's 64% of LTVs.

10 years, this is our tenth year anniversary, August 9 is going to be our tenth year anniversary as a public company. I mean if you told me we could have done this 10 years into our life, I would've never thought it possible. And I think in general, that's because of the relative discipline of the lending market, even the nonbanks or the -- I don't know what you call it, but there's another word that one of my peers use, I like it better -- alternative lending sources or something like that.

And I think we all remained disciplined and many of the larger players also have equity shops, which helped us underwrite assets because we own the assets like these that we lend against in simpler markets.

So in general, I'm just touching on the markets. And we have the apartment markets that have strengthened, not weakened, as millennials have turned back to renting. Construction, more or less in check. The office markets are very healthy, we own tens of millions of square feet. We don't actually own a lot of loans against office building in places like Manhattan, where we probably have more concern about taxes than direction of property values. We're also a little spooked out about San Francisco and potential exposure to the biggest correction, if this happens, will be in tech valuation, that could impact, as it always has, the San Francisco office markets.

And then industrial, as you know, it's been the strongest sector in property. Hotels, you've seen the earnings reports, modest RevPAR growth in city by city, asset by asset. Don't expect anything to fall off the cliff but there is a lot of construction, led by the majors who are -- keep adding flags to an already saturated market. So we have to be uber careful and land against specific assets we like.

And I don't -- again, my best case was the economy was slowing next year, significantly, and for no other reason. Not to do with Germany or Berlin or China, another throw in. I will accelerate it down, actually, but just because of the polarization of electorates, challenge of the elections, the strain on executives as they listen to socialists, static right-winger extremists, and there's nobody representing the 43% of America that is independent. And it's scary to watch the extremes go at each other and try to own the farthest reaches of the political spectrum between the parties. I think it erodes confidence. Obviously, the trade wars fought at 4:00 a.m with tweets, erode confidence, businesses get nervous. All they have to do is slow down investment and you have a recession, at least a significant slowdown.

So I can't opine on what's happening in the credit markets, but I will say that we feel pretty good. And if anything, this quarter was about strengthening our firm for the long-term, which is actually been this theme of the year.

We've done incredible work. Not me, the team, from strengthening our balance sheet. Jamie Dimon talked about JPMorgan is having a fortress balance sheet. We're the fortress balance sheet of the mortgage industry or the Commercial Lending segment. Having over -- almost $6 billion from undrawn credit facilities from our bank, $6 billion and $3.4 billion of unencumbered assets and our $3.5 billion rock-solid property booked earnings 13.2% cash returns, we're setting ourselves up, as you know, we've been working on this since our inception to achieve investment-grade and because we are multi-cylinder and these businesses are complementary. We really think it's achievable, and whenever it happens -- I ran Star Hotels, as all of you know, and our bonds traded through investment grade even though we weren't investment grade. So the credit market will decide the risk profile of our company. Even if the agencies are reluctant to get there, which happened to start with hotels. We traded though Hilton's bonds even they were investment grade and we weren't.

So I'm really happy with what we've done. I mean our focus was the downside. What happens in a downturn in the economy? And we would much rather be on financing, like CLO's, that are nonrecourse with no credit marks. And to the team's credit, they didn't want to do a CLO last year. We obviously noticed some of our peers doing them. The team convinced me the effective cost of funds over the life of their instrument was higher than the stated rates. I learned a little about finance. And this time, we actually executed a very favorable and best-in-class financing of the scale. That's the biggest one ever done since the financial crisis in the real estate area.

And then A Notes are perfect. You must realize that all of us take term risk, like we might have a financing facility that's 5 years, we might have a loan that's 5 years or we might have an investment that's 2 years or 5 years. And we don't want to finance it with 2-year paper or repo paper if we can, because banks have a very nasty habit of calling them when the (expletive) hits the fan, that's a technical term.

So A Notes are match funded. They are -- you sell a senior, you have no recourse, something goes bad, you don't have to pay off the A Notes, you just lose your investment but there's no recourse to the company. So we've moved the company aggressively away from bank lines, even though we have best-in-class bank lines, we'd still prefer not to be on them, learning the lessons of the prior crises.

So it's been a really amazing execution. You won't really see it in the dividend yields, you won't see it in our earnings. But how we get there is really important, how we sustain a downturn. Jeff talks about the LIBOR floors in our loan. We actually make more money now with LIBOR falls. We used to tell you how much money we made when LIBOR rose. Now when it falls, we'll make more money than I think almost all of our peers like, as much as $0.12?

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [6]

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$0.12, down 200.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [7]

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$0.12, down 200. We earn $0.12 more because of the floors we insist on putting on the loans as we made them. I want to point out one other thing, the special servicer, which many of you think complicates our story and explains the discount to some of our peers or one particular peer that we traded at, was about 75 basis points of the earnings this quarter. So it's almost immaterial. That's counted as nothing on our asset base. It's like $40 million out of $16-plus billion asset base. And the special servicer is really countercyclical. Like, again, we've talked about whether we should move it out, keep it, set up a little business, but if the world goes bad, our little gem will be very valuable again. And the way that the market is going, it could happen sooner than we anticipated.

One other comment, energy infrastructure, our newest cylinder. We didn't do a lot in the quarter and we put the brakes on. And again, why did we do that? It wasn't because there weren't opportunities to lend. We didn't have the right financing facility for the business. We had a 2-year facility on loans that actually would last 3 to 5 years, and when we and the Board didn't want to make loans without match financing. So the team worked really hard, created a $500 million facility, which is now in place, it's signed. The second loan coming, we hope, behind it, and now we will put the engine back to -- or the pedal back to floor and hopefully, grow that business and have it meaningfully contribute to our earnings next year, which is -- it has been a drag on our earnings. But we don't care really quarter-to-quarter, we really want to build a great company long term that we all want to own and can be proud to own.

So we held back. I think we did $50 million in the quarter, it's like insignificant. And we're getting back, and we think the returns looked to be similar or better than what we've been generating in our large loan book business.

Just one more thing on competition. It is competitive, obviously, and we're going to move to protect the quality of what we do. There's a lot of people notice the mortgage markets are a good place to park capital, given the yields of everything else in the world. So there is pressure. Obviously, spreads are going to widen out and institutions will do what they did when rates were last year, they will widen spreads. So they won't take 100 over. Micro at 150 over, so they're in the nominal 3 and the nominal 4. But the market will settle into whatever number that is.

So for us, it is competitive. We're going to be very careful about our credit. We don't have to lend. I mean we have enough engines to grow. We did not lend in the quarter or fall back on our earnings. You heard about $1 billion plus pipeline for third quarter. Hopefully, this third quarter is not done, and we are expanding our lending internationally. There are very good opportunities offshore. We think we have 6 or 7 people now focused on that in the U.K., in the continent. And we are trying to continue to find holes where we can achieve outsized returns through less risk.

I have to say I'm very pleased with the company and the balance of our business lines. I know it isn't lost on us that we've lost relative multiple book value. But we think it's the right thing to do, we have plenty of cash. We don't need to enter -- come back to the equity markets for the foreseeable future, say buying something gigantic or something like that, which I think at the moment is not in the cards.

The other thing is the residential business, which I should mention, is a hidden hero for us. We've done I think 3 securitization?

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [8]

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Yes, 4.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [9]

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Four. And each one has gotten better. We affected the machine -- we expect that business to grow dramatically, within us. And we want to increase both the hold of those mortgages on our balance sheet as well as the scale of the business, and we're working hard. By the end of the year, you'll hear something good from us in that space. And it could and should contribute meaningfully and become a major product line for us.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [10]

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If the agencies have it in the same direction and they get rid of the non-QM patch of $180 billion of production, that's 4x we are what -- we as an industry of non-bank lenders are doing and that's a massive opportunity.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [11]

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I think we said something like the fourth or fifth largest in the States now. But I expect we will get bigger.

And one other thing I will say that -- 2 other comments to close. We are the biggest market cap and so the timing of loans, funding in a quarter affects us less. That was the beauty of the scale and that's about reason alone

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Operator [12]

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Ladies and gentlemen, please hold. Our program will begin momentarily.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [13]

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Yes, we are -- we expect I think we're third, fourth, fifth largest in the space and we expect to build that business both on balance sheet and continue our securitization, achieve pretty high ROEs.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [14]

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And Barry, I mentioned that the non-QM patch, if [Collabria] pushes this through and gets them out of the business, it's $180 billion of potential loans that could leave the agencies and go to the nonbanks. I guess at some point...

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [15]

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And we expect to hopefully take advantage of that, gain market share and grow the business. Two other things about our scale and one final comment. I mean being as big as we are means the timing of the loan funding affects us less than maybe smaller peers. It's one of the joys of being big, I wish we were bigger still. We also can sit on more cash and not earn much on it. These will affect us less at our scale.

And I also think that being big, if we could, if you ask, if I wave my magic wand in one year's time, we would have a $10 billion, $12 billion, $13 billion loan book. But it's going to require that we continue to drive our cost of funds down.

So how this works is instead of lending at L300, we can lend L260. I'm making this up, but I'm just giving you an example. And if we can lower of funding from L180 to L150, we preserve our return on equity on the mezzanine. But what happens is the ability or desire of the borrower to refinance us is less because the coupons are lower to him.

So it's really important we follow this virtuous curve, which is what we've been setting ourselves up to do. Then we can rent ever more competitively, increasing the ratio of our book, decreasing repayments and still maintaining our returns on equity.

And the last thing I would say is, as you know, I think we're the largest insider-owned commercial mortgage REIT. Myself and the team own hundreds of millions of dollars of stock cumulatively. I mean we do treat your capital like it's our own because it is our own. And we're doing what we think -- maybe the market doesn't appreciate and we are frustrated with our stock price. Any 3 dividend yield in the world that's yielding 0 is ridiculous. But if you look at the quality of our assets, you take out of the equity book and apply market multiples that side of our company, we have business lines here that are quite -- are valued in other companies, actually. You can take us apart, you can take our Resi book apart, you can take our CMBS book apart, and look at a company like Ladder. So it is what it is, but we remain at bargain and in a world of uncertainty.

So thank you very much.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [16]

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I'll turn it for questions. Please, operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Doug Harter with Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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I guess if we look back to the December about the volatility, you guys pulled back. Kind of, as that was happening, kind of the volatility we're going through today, do you kind of view that as an opportunity for -- the lend that wider spreads or kind of are you looking to kind of pull back into this spread of volatility?

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [3]

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I'd say we're all pedal to the floor for the right opportunity. We're not constrained by size. Obviously, with $1 billion dollar loan capacity, plenty of cash which we didn't have as much cashback in December. We just bought, I think, the EIF business. And we actually, we're trying to make sure we didn't have to come back to the market to finance that. So as you know, we've been selling off the lower-yielding loans out of the EIF, I think half the size of what -- when we bought it.

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Andrew Jay Sossen, Starwood Property Trust, Inc. - COO, General Counsel, Chief Compliance Officer, Executive VP & Secretary [4]

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Yes, between sales and repayments, it's been about between $800 million and $900 million of sales in repayments since then.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [5]

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Right. And that's okay, because those -- while they're accretive to our cost of debt, it was not accretive -- this wasn't the highest-yielding subs we had. And so, we're -- this is sort of a transition year, if you will, to get all our cylinders built. Next year, with the Resi business, hopefully a larger large loan book, maybe the special services lines are -- in a happy position. Obviously, our CMBS book is worth more not less in this kind of environment. So I think -- and then the IF business, the infrastructure business, full steam ahead putting out loans. And you will see us probably securitize those loans much like we have in the non-QM business, and obviously, what our conduit businesses does, which also had a good quarter.

So all in all, I'm pretty -- I think we're set up really well, continue to drive the enterprise. And if you can create these kinds of earnings in this interest rate environment on a repeated basis, you're doing a really good job.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [6]

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And Doug, I would say that our pipeline report that I'm now showing Barry, is up to 3 pages today. It hasn't been 3 pages in well over a year, we're seeing a lot more opportunities. There's up trading. We have more cash, as Barry said, due to some early prepayments, due to fifth sales, our Term Loan B, we took out an incremental $100 million versus our Term Loan A and we have pro forma, as you know, and equity sale and some cash-out refi. So it's a great time for us, if there's an opportunity.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [7]

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The equity sale being asset out of [the basket], it's not -- and Jeff also mentioned the cash-out refis. I mean we're still flushed with cash, and this is on 2 of our equity assets, and I'm like, "Do we need this money? So we're paying off bank lines, right?" So with mortgage debt and cheaper spreads. Not much cheaper, but it pays off bank lines.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [8]

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So we're going to pay positive carry to hold more cash, effectively.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [9]

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Right. So I mean we'll take advantage of the markets. It's probably even better than what it was when we priced it a little while ago. So it's really -- it's really a bizarre time. But no, we're not going to step back. We're very confident in what we think values are in the property markets.

And the only thing we worry about, obviously, is the calamitous recession, led in part due to trade war and the volatility and the global economies. I mean the President got a little lucky. The decline in some European economy, is in full bloom, obviously, negative, pulled the U.S. rates down in a time when 100 out of 100 economists would have expected the tenure to be 3.5, not 1.6. And really, you have to attribute it a little bit -- $1 trillion deficit. As far as I can see, until last month, we were selling our -- the fed was reducing its balance sheet. To me, this is truly an astonishing outcome. Little scary, actually, but astonishing.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [10]

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And then just, Jeff, just to be clear on that pipeline report, is that mostly in commercial lending or were all...

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [11]

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Yes, yes. That's right. The commercial lending report, there's just more activity right now than we've seen in a while.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [12]

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And there's a backlog of the loans on EIFs, too, on the energy and infrastructure side.

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Operator [13]

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Our next question comes from the line of Jade Rahmani with KBW.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [14]

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I appreciate the multicylinder platform, the long-term value of the special servicer and the steps you've taken on the balance sheet to reduce dependence on warehouse facilities. If you optimize the balance sheet for reinvestment of gains on the property side, as well as the refinancings that you talked about undertaking, how much incremental earnings power do you think that could create? Is it possible to put any parameters around that?

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [15]

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You must have been talking to Jeff off-line. He wants me to sell all the real estate assets so he can take that $700 million of gains and be deployed onto -- I'm intoxicated with the 13 yield that's actually just plain (inaudible) direction, unless incomes fall in Orlando and Tampa, which are hard to imagine.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [16]

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And again, (inaudible) without it.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [17]

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Of course, of course, that cash on yield will continue to rise. So I can't replace -- I mean, when we bought that stuff, it was my intention to hold these assets forever because I said this, I like to own these forever, and they're producing a double-digit cash on cash yields, and I believe, one of them has 17-year debt or 13-year debt, 6? They're both 6 so we have no exposure to REITS. It's the safest thing -- I mean you put this in all of your kids' trust funds, and you get to buy it through our stock at an age, which is ridiculous.

So I'm reluctant to sell those. They're affordable housing, they will run 99% occupancy in almost any scenario because they're cheaper than market rate, obviously, even though we're getting these rate increases and it's unimaginable to me that it's that far given the economy on those two markets is going to suffer any kind of income downturn over the next foreseeable future, let's say 5 years, because that's as far as the ball goes. So those assets will continue to grow. And then our medical office, it's pretty much 2-plus percent growth built in, maybe higher but the floor will be 2% or 3%, which in this kind of rate environment, looks pretty good. And then Cabela's, we're down to a relatively small amount of assets earning us 13% or something also cash yields. So and there's no issues there.

So I -- we will do the analysis because Jeff is all over me all the time to look at this. But I don't want to replace it. The reason that book is existing here, is the duration of our Lending business. I mean the loans are 2.6, duration average term, something like that. Some others are 3, but they're 3, not forever. And so it gives us a base of assets, earning a double-digit cash-on-cash yield, actually, they're hurting our book value obviously, we're depreciating them every day. But I tend to think these are great assets to own. If we stop buying them, we said to ourselves, we would do like 25% to 30% of our cap in equity assets. That was led in part by guidance from the rating agencies. And if other opportunities arise and as our balance sheet grows, we could an incremental to the portfolio, it's just hard to find 10 cash on cash yields on equity...

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [18]

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So rather than replace them, Jade, we are refinancing them and we'll take cash out. And when we get the do-part of what I want to do, which is eventually reinvest that capital as 10%, 12%, 13% whatever, a safe return, and incrementally, that will add a tremendous amount. To the refis, I mentioned earlier, will add about $180 million and we if we make up a property sale with a gain that will add some more and multiply that by whatever you think is safe...

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [19]

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Every significant portion of that back to work. That's a good point. So you're seeing the gains in that where you're able to take out $180 million -- is a little more than you more than -- going to be over $300 million, if and when we sell the (inaudible) marketing for the (inaudible) market.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [20]

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Is the Dublin portfolio a candidate for asset sales? I believe there's been some reports to that effect.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [21]

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That's the portfolio we're looking to sell, correct. And that's Bloomberg and the press, so I'm saying it efficiently that that's correct. And again, it's had a great run, great assets. So we expect it will be a profitable sale. And we thought, Jade, it might help if we demonstrate it in factually, if these gains we talk about actually do exist and then I'll -- we'll provide all the information we have if you want to go value our multifamily to confirm our valuations of those. So you can see that there's about $400-plus million of gains in 2 multifamily portfolio, Jade.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [22]

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Okay. Lastly, a company that used to be involved with called iStar has solely pivoted its strategic focus to ground leases. Do you have views on the merits of either the investment as an investor or whether as a financing tool, that can be a way to unlock value within the Property segment? They're offering 99-year ground leases with initial cap rates in the 3% range or in some cases, below that.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [23]

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Look, I've been doing this 30-plus years. So with the ground leased assets, like encumbered hotels have fewer buyers. Some buyers want fee, so it's sum of the parts, greater than the whole. At the moment, there's distortions in the market and it's possible that's the case. We looked at it and we did it ourselves on the portfolio of assets in the U.K., bunch of hotels we own, and we did some with ground leases, some we sold outright. It's a viable business. Because there's -- it's not done a lot because people don't -- it's another way of financing obviously. In this environment, I can suppose it's something we can look at, especially on maybe our multi, because we're going to hold the upside.

But it's -- the competitor that does it, they have a 186 yields, and that's fascinating. So we have an 83 yield, and they're a REIT, too. So it's interesting. I mean I would not have expected a ton of volume in this, but if you're going to own assets forever, like we might with our multis, that's an interesting suggestion and we should look at that. It never -- I'm there for the -- we have to look at how it works with the financing in place, too. I think we have existing debt. So pretty sure it would be complicated.

And until recently, I would've thought that debt was the way in the money. So I'm not sure it is anymore given the rates have moved. I think it was like, 173, 273? The debt on the leasing portfolio? It was really cheap.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [24]

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We'll get it. We got it.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [25]

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Okay. Thanks.

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Operator [26]

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Our next question comes from the line of Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [27]

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Jeff, back in Investor Day, you had outlined a strategy, focusing, in part, on states that you felt would benefit from the salt distortion. I'm curious if you -- that is continuing to manifest and if you're seeing any price dislocations in those markets as peers or competitors pursue that same strategy?

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [28]

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Yes, I think it's the same. Listen, what we do here is we follow our managers at Starwood Capital Group, which has a strong opinion, tremendous amounts of bodies of the grounds and data. Our managers at Starwood Capital Group have been leaning into the low tax states, migration states and we've done the same. Our lending book has certainly moved more into Texas and Houston and Dallas and Austin, in areas there and some great areas and in Northern Florida and we've been looking at Nashville and others with others. So we still believe in population's demographics and where people are moving in low tax states as a really important trend. I think it's helping our Orlando, in North Central, Northern Florida, multifamily-owned portfolio outperform by as much as it is. I think a big part of that is what we're seeing down there for growth in those economies. I think Orlando was the #1 or the #2 growth MSA in the country this year. We just heard, Universal Studios is going to add another massive theme park there that was announced late last week, and that will be another 14,000 jobs to that market. So yes, we continue to follow our manager into those markets and think that that's a really good market.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [29]

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Yes. I'd say that we're kind of -- we're looking at our tax end points very closely in these markets and what is there's -- I should say -- I mean the markets are losing a little bit discipline. When you can finance its higher proceeds than you can sell an asset for, and then you're at 60% of value, you're kidding yourself. There's some really aggressive loans being done in the hotel space, like end of cycle kind of loans. Luxury hotels with forecast. I mean hotels shouldn't be a forecast.

So interestingly, with the trade wars, the biggest source of capital for some of these deals has been offshore, particularly Southeast Asia then Korea, obviously, China's out. So there aren't that many people looking to buy some of these. But you're seeing some incredible deals done, particularly in the hotel space where, I think, the cap rates are seriously in question and the coverage ratios are questionable. And I've seen this movie before, twice, I've seen the world end for these assets. So -- and we're being pretty careful about what we lend against, and we let the other firms make those loans and we'll just step aside.

And we also, as a matter, of course, we've not chosen to do much with our funds. We don't -- we don't lend to ourselves typically. And again, that's never a problem until it's a problem. So I think it's a very -- you have to look below the hood. And our dividend yields just doesn't make any sense given the scale of the company and our competitive -- the competitive universe of the company. They trade in line with us on our dividend. It's impossible to see that's the case. They're all mortgage REITs. They have nothing in them except a bunch of loans. They revert to cash, to par, to book. We don't. We don't, we have a property book. We have all these other assets. They don't revert to that. But we say that every quarter, maybe someday we'll be right.

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Operator [30]

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Our final question comes from the line of Tim Hayes with B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [31]

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Look, my first one, I just wanted to thank you for the comments on the QM patch and non-QM and all that, and just a follow-up there. I know you mentioned market share. But just wondering what expected annual volumes for impact is this year and next year.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [32]

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Yes. We don't own impact with one buyer and we've done some trade impact securitizations. We obviously have a preferred equity investment that will turn to equity on and an originator of our own. We have a handful of other originators that we've been working with. There's no one relationship that will significantly dominate where we're getting our production from, and we think it's important to have multiple sources. And when you produce these loans by yourself and you save 1.5, that 1.5 does a heck of a lot to your IRR. And our goal is to originate as many as we can and grow smartly in that space rather than just be the highest bid for premium bonds. These loans, the loan prices have gone up relatively significant as rates have come down. But we don't want to be just buying $104.5 price pools from the most prestigious originators. So it continues to diversify.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [33]

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Just to translate for the laymen. You sounded like a super scientist, like a mad scientist. This business will be almost a couple of billion dollars this year, origination and maybe higher. We're driving it higher as one of the quality states and the pricing works for us. The key here is the originator, which Jeff mentioned will close when we have the government approvals and they just have to get fingerprinted. And that will close probably by the end of the year and that will drive and allow us to accelerate and get better outcomes and better returns and should build an integrated business for the benefit of the REIT inside of us. One -- the business runs on higher leverage levels. So it's going to slightly skew our financials and even with that we still can get close to our largest peer. But we will drift that way. But again, we're going to split the book and own some of these assets on our book and create a whole platform, higher integrated company.

So that business is running quite well. And we believe our team has done great job, and I hope we'll be able to report great things in that business as it grows and it should -- could be material, and I hope it is.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [34]

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Okay. And then just switching gears to Infrastructure. I think you mentioned $800 million and $900 million of aggregate repayments in sales in the portfolio so far since acquiring that from GE. Just how much rotation do we have left there? And then I think you noted a growing backlog, but at what point should we think about the portfolio growing, especially now that you have that new facility in place?

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Andrew Jay Sossen, Starwood Property Trust, Inc. - COO, General Counsel, Chief Compliance Officer, Executive VP & Secretary [35]

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So it's Andrew. So as I said, we've had about close to $350 million of sales and around $540 million, $550 million of repayments since we acquired the business back in September. So we've rotated through a majority of the lower-yielding assets. There's a couple of $100 million left, call it less than $200 million of loans that we would look to opportunistically sell at the right dollar price, but we don't have to a gun to our head to force them out into markets. As I said, we remain opportunistic in terms of trying to find the right buyers at the right time.

We work a little bit on our back foot, right, in the quarter, as Barry mentioned before. We've been working on putting our second financing line in place, and it took significantly longer than any of us expected. We're really creating a new industry, right? When you think about kind of where this financing of this asset class is, it's very reminiscent of where we were back in '09 and 2010 where we took Starwood Property Trust public, we were trying to restart the commercial real estate warehouse business, right? I mean at the time, we put $250 million line in place with our friends at Wells Fargo. That's grown to $2 billion, right, over time. So we're making really good progress on finding financing. The new facility we've put in place is up to kind of 9 years of available financing on it. So it's really attractive in terms of kind of matching duration. We have another $500 million line that we're in the process of negotiating and $500 million plus of...

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [36]

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Risk aversion? Like we could have made those along in the quarter, right? We could have put them on the existing facilities that we've got or put them in place when we did the transaction with GE. And we opted not to do that, because we didn't really get hung on the 2-year facility with 5 -- 3, 5 year loans. So we could have done it. We could have taken them off that facility into a new facility, but we just said, what's -- we don't need to do that. Why should we take that kind of risk?

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Andrew Jay Sossen, Starwood Property Trust, Inc. - COO, General Counsel, Chief Compliance Officer, Executive VP & Secretary [37]

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Yes. We probably passed on $400 million to $500 million of production. Then that thing, we would have done it all, but things didn't screen because we didn't have available financing. And one other important thing to note, Barry referenced we could be a CLO issuer, securitization issuer in the space. There is a burgeoning market, right, for CLO energy and infrastructure finance asset. CLO got done in July, in that asset class, around $0.5 billion facility with pretty attractive terms. So the teams, now that we've closed our highly successful CRE CLO, the team is turning its full attention to looking at energy infrastructure CLOs and again, that's something you can see us do in Q4, Q1.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [38]

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Okay, and if those Resi books' going to do $2 billion, $3 billion, $4 billion of origination, which is feasible, this business should be over $1 billion, and be $1.5 billion, would be a reasonable target. And the returns are -- actually the shape of the return is different than those in the Resi book. The accounting -- the GAAP accounting for the Resi book is in argue -- dramatically understated the returns available to us and we've been having quite a brouhaha internally, trying to figure out that we follow GAAP obviously, and the conventions to public market, but we do think returns are actually higher than we're telling you. So there's no assumptions about what happens to these loans as they mature before they get the underlying mortgages there and the replacement pays down. And you can't book any of that even though you think it's going to work out a certain way. So we think the IRRs are quite attractive on the retainer.

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [39]

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And I would say, with gas prices having come down a bit, I asked the team to run some back of the envelope numbers, and if GAAP halved from here, and it's dropped from in the 3s to in the low 2s now, if it halved from here, our LTVs would only go up by 4% on our loan portfolio. It's our ballpark, yes. So we're not exposed to the price of the underlying commodity.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [40]

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You mean the energy book?

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Jeffrey F. DiModica, Starwood Property Trust, Inc. - President & MD [41]

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Yes, in the energy book.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [42]

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(inaudible) in the whole company? Really? I didn't think they (inaudible) had any exposure to the energy markets like that. That would -- how big is the book now? Like...

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Andrew Jay Sossen, Starwood Property Trust, Inc. - COO, General Counsel, Chief Compliance Officer, Executive VP & Secretary [43]

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About $1 billion, $1.5 billion.

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Barry Stuart Sternlicht, Starwood Property Trust, Inc. - Chairman & CEO [44]

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$1.5 billion? Is that, what, 5% of our assets? 8%, 6%, 7%? So 4%, 5% is nothing. Beauty of diversification.

So we appreciate you being with us today, and have a great August and the rest of the summer. Thanks, and let's hope the world holds together. Okay. Bye.

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Operator [45]

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