10-Q 1 a14-9436_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2014

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34436

 


 

Starwood Property Trust, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

27-0247747

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

591 West Putnam Avenue

 

 

Greenwich, Connecticut

 

06830

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(203) 422-8100

 


 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of May 6, 2014 was 221,385,672.

 

 

 



Table of Contents

 

Special Note Regarding Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward-looking statements, including without limitation, statements concerning our operations, economic performance and financial condition. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are developed by combining currently available information with our beliefs and assumptions and are generally identified by the words “believe,” “expect,” “anticipate” and other similar expressions. Forward-looking statements do not guarantee future performance, which may be materially different from that expressed in, or implied by, any such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates.

 

These forward-looking statements are based largely on our current beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or within our control, and which could materially affect actual results, performance or achievements. Factors that may cause actual results to vary from our forward-looking statements include, but are not limited to:

 

·                  factors described in our Annual Report on Form 10-K for the year ended December 31, 2013, including those set forth under the captions “Risk Factors” and “Business”;

 

·                  defaults by borrowers in paying debt service on outstanding indebtedness;

 

·                  impairment in the value of real estate property securing our loans;

 

·                  availability of mortgage origination and acquisition opportunities acceptable to us;

 

·                  our ability to fully integrate LNR Property LLC, a Delaware limited liability company (“LNR”), which was acquired on April 19, 2013, into our business and achieve the benefits that we anticipate from this acquisition;

 

·                  potential mismatches in the timing of asset repayments and the maturity of the associated financing agreements;

 

·                  national and local economic and business conditions;

 

·                  general and local commercial and residential real estate property conditions;

 

·                  changes in federal government policies;

 

·                  changes in federal, state and local governmental laws and regulations;

 

·                  increased competition from entities engaged in mortgage lending and securities investing activities;

 

·                  changes in interest rates; and

 

·                  the availability of and costs associated with sources of liquidity.

 

In light of these risks and uncertainties, there can be no assurances that the results referred to in the forward-looking statements contained in this Quarterly Report on Form 10-Q will in fact occur. Except to the extent required by applicable law or regulation, we undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, changes to future results over time or otherwise.

 

2



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

Part I

Financial Information

 

Item 1.

Financial Statements

4

 

Condensed Consolidated Balance Sheets

4

 

Condensed Consolidated Statements of Operations

5

 

Condensed Consolidated Statements of Comprehensive Income

6

 

Condensed Consolidated Statements of Equity

7

 

Condensed Consolidated Statements of Cash Flows

8

 

Notes to Condensed Consolidated Financial Statements

10

 

Note 1 Business and Organization

10

 

Note 2 Summary of Significant Accounting Policies

11

 

Note 3 Acquisitions and Divestitures

14

 

Note 4 Loans

15

 

Note 5 Investment Securities

17

 

Note 6 Investment in Unconsolidated Entities

22

 

Note 7 Goodwill and Intangible Assets

23

 

Note 8 Secured Financing Agreements

24

 

Note 9 Convertible Senior Notes

25

 

Note 10 Loan Securitization/Sale Activities

26

 

Note 11 Derivatives and Hedging Activity

27

 

Note 12 Offsetting Assets and Liabilities

29

 

Note 13 Variable Interest Entities

29

 

Note 14 Related-Party Transactions

30

 

Note 15 Stockholders’ Equity

31

 

Note 16 Earnings per Share

32

 

Note 17 Accumulated Other Comprehensive Income

34

 

Note 18 Benefit Plans

34

 

Note 19 Fair Value

34

 

Note 20 Income Taxes

39

 

Note 21 Commitments and Contingencies

40

 

Note 22 Segment Data

41

 

Note 23 Subsequent Events

45

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

46

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

59

Item 4.

Controls and Procedures

60

Part II

Other Information

 

Item 1.

Legal Proceedings

61

Item 1A.

Risk Factors

61

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

61

Item 3.

Defaults Upon Senior Securities

61

Item 4.

Mine Safety Disclosures

61

Item 5.

Other Information

61

Item 6.

Exhibits

63

 

3



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Balance Sheets

(Unaudited, amounts in thousands, except share data)

 

 

 

As of
March 31, 2014

 

As of
December 31, 2013

 

Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

226,471

 

$

317,627

 

Restricted cash

 

43,117

 

69,052

 

Loans held-for-investment, net

 

4,634,923

 

4,363,718

 

Loans held-for-sale, at fair value

 

186,837

 

206,672

 

Loans transferred as secured borrowings

 

143,042

 

180,414

 

Investment securities ($553,933 and $566,789 held at fair value)

 

923,085

 

935,107

 

Intangible assets—servicing rights ($144,898 and $150,149 held at fair value)

 

168,056

 

177,173

 

Residential real estate, net

 

 

749,214

 

Non-performing residential loans

 

 

215,371

 

Investment in unconsolidated entities

 

104,520

 

122,954

 

Goodwill

 

140,437

 

140,437

 

Derivative assets

 

4,617

 

7,769

 

Accrued interest receivable

 

34,515

 

37,630

 

Other assets

 

111,223

 

95,813

 

Variable interest entity (“VIE”) assets, at fair value

 

118,451,518

 

103,151,624

 

Total Assets

 

$

125,172,361

 

$

110,770,575

 

Liabilities and Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

137,831

 

$

225,374

 

Related-party payable

 

29,458

 

17,793

 

Dividends payable

 

95,424

 

90,171

 

Derivative liabilities

 

18,057

 

24,192

 

Secured financing agreements, net

 

2,601,062

 

2,257,560

 

Convertible senior notes, net

 

1,000,839

 

997,851

 

Secured borrowings on transferred loans

 

143,038

 

181,238

 

VIE liabilities, at fair value

 

117,931,005

 

102,649,263

 

Total Liabilities

 

121,956,714

 

106,443,442

 

Commitments and contingencies (Note 21)

 

 

 

 

 

Equity:

 

 

 

 

 

Starwood Property Trust, Inc. Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $0.01 per share, 100,000,000 shares authorized, no shares issued and outstanding

 

 

 

Common stock, $0.01 per share, 500,000,000 shares authorized, 196,711,522 issued and 196,085,672 outstanding as of March 31, 2014 and 196,139,045 issued and 195,513,195 outstanding as of December 31, 2013

 

1,967

 

1,961

 

Additional paid-in capital

 

3,192,245

 

4,300,479

 

Treasury stock (625,850 shares)

 

(10,642

)

(10,642

)

Accumulated other comprehensive income

 

80,115

 

75,449

 

Accumulated deficit

 

(59,542

)

(84,719

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

3,204,143

 

4,282,528

 

Non-controlling interests in consolidated subsidiaries

 

11,504

 

44,605

 

Total Equity

 

3,215,647

 

4,327,133

 

Total Liabilities and Equity

 

$

125,172,361

 

$

110,770,575

 

 

See notes to condensed consolidated financial statements.

 

4



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Operations

(Unaudited, amounts in thousands, except per share data)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Revenues:

 

 

 

 

 

Interest income from loans

 

$

104,910

 

$

67,690

 

Interest income from investment securities

 

29,454

 

16,240

 

Servicing fees

 

34,211

 

 

Other revenues

 

3,404

 

79

 

Total revenues

 

171,979

 

84,009

 

Costs and expenses:

 

 

 

 

 

Management fees

 

27,821

 

15,069

 

Interest expense

 

37,831

 

17,426

 

General and administrative

 

46,101

 

4,038

 

Business combination costs

 

 

4,196

 

Acquisition and investment pursuit costs

 

394

 

81

 

Depreciation and amortization

 

4,636

 

 

Loan loss allowance

 

497

 

30

 

Other expense

 

1,689

 

33

 

Total costs and expenses

 

118,969

 

40,873

 

Income before other income, income taxes and non-controlling interests

 

53,010

 

43,136

 

Other income:

 

 

 

 

 

Income of consolidated VIEs, net

 

56,004

 

 

Change in fair value of servicing rights

 

(5,251

)

 

Change in fair value of investment securities, net

 

8,361

 

405

 

Change in fair value of mortgage loans held-for-sale, net

 

20,893

 

 

Earnings from unconsolidated entities

 

64

 

741

 

Gain on sale of investments, net

 

1,555

 

13,524

 

(Loss) gain on derivative financial instruments, net

 

(7,866

)

16,228

 

Foreign currency gain (loss), net

 

1,477

 

(7,665

)

Total other-than-temporary impairment (“OTTI”)

 

(1,192

)

(527

)

Noncredit portion of OTTI recognized in other comprehensive income (loss)

 

979

 

485

 

Net impairment losses recognized in earnings

 

(213

)

(42

)

Other income, net

 

18

 

 

Total other income

 

75,042

 

23,191

 

Income from continuing operations before income taxes

 

128,052

 

66,327

 

Income tax provision

 

(5,620

)

(615

)

Income from continuing operations

 

122,432

 

65,712

 

Loss from discontinued operations, net of tax (Note 3)

 

(1,551

)

(2,288

)

Net income

 

120,881

 

63,424

 

Net income attributable to non-controlling interests

 

(280

)

(1,181

)

Net income attributable to Starwood Property Trust, Inc.

 

$

120,601

 

$

62,243

 

 

 

 

 

 

 

Per share data:

 

 

 

 

 

Basic earnings per share data:

 

 

 

 

 

Income from continuing operations attributable to Starwood Property Trust, Inc.

 

$

0.62

 

$

0.47

 

Loss from discontinued operations attributable to Starwood Property Trust, Inc.

 

(0.01

)

(0.01

)

Net income attributable to Starwood Property Trust, Inc.

 

$

0.61

 

$

0.46

 

Diluted earnings per share data:

 

 

 

 

 

Income from continuing operations attributable to Starwood Property Trust, Inc.

 

$

0.61

 

$

0.47

 

Loss from discontinued operations attributable to Starwood Property Trust, Inc.

 

(0.01

)

(0.01

)

Net income attributable to Starwood Property Trust, Inc.

 

$

0.60

 

$

0.46

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.48

 

$

0.44

 

 

See notes to condensed consolidated financial statements.

 

5



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Comprehensive Income

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Net income

 

$

120,881

 

$

63,424

 

Other comprehensive income (loss) (net change by component):

 

 

 

 

 

Cash flow hedges

 

122

 

279

 

Available-for-sale securities

 

3,498

 

(2,349

)

Foreign currency remeasurement

 

1,046

 

(7,061

)

Other comprehensive income (loss)

 

4,666

 

(9,131

)

Comprehensive income

 

125,547

 

54,293

 

Less: Comprehensive income attributable to non-controlling interests

 

(280

)

(1,181

)

Comprehensive income attributable to Starwood Property Trust, Inc.

 

$

125,267

 

$

53,112

 

 

See notes to condensed consolidated financial statements.

 

6



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

Condensed Consolidated Statements of Equity

(Unaudited, amounts in thousands, except share data)

 

 

 

Common stock

 

Additional

 

 

 

 

 

 

 

Accumulated
Other
Comprehensive

 

Total
Starwood
Property
Trust, Inc.

 

Non-

 

 

 

 

 

 

 

Par

 

Paid-In

 

Treasury Stock

 

Accumulated

 

Income

 

Stockholders’

 

Controlling

 

Total

 

 

 

Shares

 

Value

 

Capital

 

Shares

 

Amount

 

Deficit

 

(Loss)

 

Equity

 

Interests

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2014

 

196,139,045

 

$

1,961

 

$

4,300,479

 

625,850

 

$

(10,642

)

$

(84,719

)

$

75,449

 

$

4,282,528

 

$

44,605

 

$

4,327,133

 

Stock-based compensation

 

434,189

 

4

 

7,203

 

 

 

 

 

7,207

 

 

7,207

 

Manager incentive fee paid in stock

 

138,288

 

2

 

3,306

 

 

 

 

 

3,308

 

 

3,308

 

Net income

 

 

 

 

 

 

120,601

 

 

120,601

 

280

 

120,881

 

Dividends declared, $0.48 per share

 

 

 

 

 

 

(95,424

)

 

(95,424

)

 

(95,424

)

Spin-off of Starwood Waypoint Residential Trust

 

 

 

(1,118,743

)

 

 

 

 

(1,118,743

)

(1,594

)

(1,120,337

)

Other comprehensive income, net

 

 

 

 

 

 

 

4,666

 

4,666

 

 

4,666

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

(31,787

)

(31,787

)

Balance, March 31, 2014

 

196,711,522

 

$

1,967

 

$

3,192,245

 

625,850

 

$

(10,642

)

$

(59,542

)

$

80,115

 

$

3,204,143

 

$

11,504

 

$

3,215,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2013

 

136,125,356

 

$

1,361

 

$

2,721,353

 

625,850

 

$

(10,642

)

$

(72,401

)

$

79,675

 

$

2,719,346

 

$

77,859

 

$

2,797,205

 

Convertible senior notes

 

 

 

28,118

 

 

 

 

 

28,118

 

 

28,118

 

Stock-based compensation

 

187,501

 

2

 

4,654

 

 

 

 

 

4,656

 

 

4,656

 

Manager incentive fee paid in stock

 

13,188

 

 

366

 

 

 

 

 

366

 

 

366

 

Net income

 

 

 

 

 

 

62,243

 

 

62,243

 

1,181

 

63,424

 

Dividends declared, $0.44 per share

 

 

 

 

 

 

(60,147

)

 

(60,147

)

 

(60,147

)

Other comprehensive loss, net

 

 

 

 

 

 

 

(9,131

)

(9,131

)

 

(9,131

)

Contributions from non-controlling interests

 

 

 

 

 

 

 

 

 

6

 

6

 

Distribution to non-controlling interests

 

 

 

 

 

 

 

 

 

(44,098

)

(44,098

)

Balance, March 31, 2013

 

136,326,045

 

$

1,363

 

$

2,754,491

 

625,850

 

$

(10,642

)

$

(70,305

)

$

70,544

 

$

2,745,451

 

$

34,948

 

$

2,780,399

 

 

See notes to condensed consolidated financial statements.

 

7



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net income

 

$

120,881

 

$

63,424

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Amortization of deferred financing costs

 

2,895

 

3,193

 

Amortization of convertible debt discount and deferred fees

 

2,988

 

841

 

Accretion of net discount on investment securities

 

(7,398

)

(9,180

)

Accretion of net deferred loan fees and discounts

 

(1,806

)

(7,856

)

Amortization of premium from secured borrowings on transferred loans

 

(787

)

(374

)

Share-based compensation

 

7,207

 

4,656

 

Share-based component of incentive fees

 

3,308

 

366

 

Change in fair value of fair value option investment securities

 

(8,361

)

 

Change in fair value of consolidated VIEs

 

(21,877

)

 

Change in fair value of servicing rights

 

5,251

 

 

Change in fair value of loans held-for-sale

 

(20,893

)

 

Change in fair value of derivatives

 

7,110

 

(16,318

)

Foreign currency (gain) loss, net

 

(1,492

)

7,390

 

Gain on non-performing loans and sale of investments

 

(2,498

)

(15,004

)

Other-than-temporary impairment of investment securities

 

213

 

42

 

Loan loss allowance

 

497

 

30

 

Depreciation and amortization

 

5,786

 

713

 

Earnings from unconsolidated entities

 

(64

)

 

Distributions of earnings from unconsolidated entities

 

956

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

Related-party payable, net

 

11,665

 

9,307

 

Accrued interest receivable, less purchased interest

 

3,063

 

1,802

 

Other assets

 

(20,474

)

5,839

 

Accounts payable, accrued expenses and other liabilities

 

(22,574

)

35,984

 

Originations of loans held-for-sale, net of principal collections

 

(261,733

)

 

Proceeds from sale of loans held-for-sale

 

302,461

 

 

Net cash provided by operating activities

 

104,324

 

84,855

 

Cash Flows from Investing Activities:

 

 

 

 

 

Spin-off of Starwood Waypoint Residential Trust

 

(111,960

)

 

Purchase of investment securities

 

(9,890

)

(37,175

)

Proceeds from sales of investment securities

 

27,883

 

19,480

 

Proceeds from principal collections on investment securities

 

8,227

 

21,726

 

Origination and purchase of loans held-for-investment

 

(728,594

)

(129,817

)

Proceeds from principal collections on loans

 

316,428

 

93,651

 

Proceeds from loans sold

 

146,400

 

44,631

 

Acquisition and improvement of single family homes

 

(61,901

)

(114,925

)

Proceeds from sale of single family homes

 

1,784

 

3,360

 

Purchase of non-performing loans

 

 

(104,142

)

Proceeds from sale of non-performing loans

 

1,153

 

 

Distribution of capital from unconsolidated entities

 

17,834

 

150

 

Payments for purchase or termination of derivatives

 

(11,274

)

 

Proceeds from termination of derivatives

 

799

 

 

Return of investment basis in purchased derivative asset

 

407

 

518

 

Deposit on purchase of LNR

 

 

(40,665

)

Decrease (increase) in restricted cash, net

 

234

 

(38,040

)

Net cash used in investing activities

 

(402,470

)

(281,248

)

 

See notes to condensed consolidated financial statements.

 

8



Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

 

Condensed Consolidated Statements of Cash Flows (Continued)

(Unaudited, amounts in thousands)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Cash Flows from Financing Activities:

 

 

 

 

 

Borrowings under financing agreements

 

$

997,767

 

$

347,521

 

Proceeds from issuance of convertible senior notes

 

 

587,700

 

Principal repayments on borrowings

 

(656,573

)

(625,513

)

Payment of deferred financing costs

 

(7,418

)

(24

)

Payment of dividends

 

(90,171

)

(73,796

)

Contributions from non-controlling interests

 

 

6

 

Distributions to non-controlling interests

 

(31,788

)

(44,098

)

Issuance of debt of consolidated VIEs

 

45,761

 

 

Repayment of debt of consolidated VIEs

 

(53,385

)

 

Distributions of cash from consolidated VIEs

 

2,740

 

 

Net cash provided by financing activities

 

206,933

 

191,796

 

Net decrease in cash and cash equivalents

 

(91,213

)

(4,597

)

Cash and cash equivalents, beginning of period

 

317,627

 

177,671

 

Effect of exchange rate changes on cash

 

57

 

 

Cash and cash equivalents, end of period

 

$

226,471

 

$

173,074

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

44,638

 

$

10,536

 

Income taxes paid

 

2,725

 

327

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Net assets distributed in spin-off of Starwood Waypoint Residential Trust

 

$

1,008,377

 

$

 

Dividends declared, but not yet paid

 

95,424

 

60,147

 

Unsettled trade receivable

 

 

206,608

 

Consolidation of VIEs (VIE asset/liability additions)

 

20,236,513

 

 

Deconsolidation of VIEs (VIE asset/liability reductions)

 

1,289,569

 

 

Conversion of non-performing residential loans to residential real estate

 

3,590

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

Starwood Property Trust, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

As of March 31, 2014

(Unaudited)

 

1. Business and Organization

 

Starwood Property Trust, Inc. (“STWD” together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations in August 2009, upon the completion of our initial public offering (“IPO”). We are focused primarily on originating, acquiring, financing and managing commercial mortgage loans and other commercial real estate debt investments, commercial mortgage-backed securities (“CMBS”), and other commercial real estate-related debt investments in both the U.S. and Europe. We refer to the following as our target assets:

 

· commercial real estate mortgage loans, including preferred equity interests;

 

· CMBS; and

 

· other commercial real estate-related debt investments.

 

We may also invest in residential mortgage-backed securities (“RMBS”), certain residential mortgage loans, distressed or non-performing commercial loans, commercial properties subject to net leases and commercial real estate owned. As market conditions change over time, we may adjust our strategy to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions.

 

We have three reportable business segments which include:

 

·                  Real estate investment lending (the “Lending Segment”)—includes all business activities of the Company, excluding the single family residential and LNR businesses, which generally represents investments in real estate related loans and securities that are held-for-investment.

 

·                  LNR—includes all business activities of the acquired LNR Property LLC (“LNR”) business excluding the consolidation of securitization VIEs.

 

·                  Single family residential (“SFR”)—includes the business activities associated with our investments in single-family residential properties and non-performing single-family residential mortgage loans.  This segment was spun off on January 31, 2014 as discussed below and in Note 3 herein.

 

On April 19, 2013, we acquired the equity of LNR and certain of its subsidiaries for an initial agreed upon purchase price of approximately $859 million, which was reduced for transaction expenses and distributions occurring after September 30, 2012, resulting in cash consideration of approximately $730 million. Immediately prior to the acquisition, an affiliate of the Company acquired the remaining equity comprising LNR’s commercial property division for a purchase price of $194 million. The portion of the LNR business acquired by us includes the following: (i) servicing businesses in both the U.S. and Europe that manage and work out problem assets, (ii) a finance business that is focused on selectively acquiring and managing real estate finance investments, including unrated, investment grade and non-investment grade rated CMBS, including subordinated interests of securitization and resecuritization transactions, and high yielding real estate loans; and (iii) a mortgage loan business which originates conduit loans for the primary purpose of selling these loans into securitization transactions.

 

On January 31, 2014, we completed the spin-off of our SFR segment to our stockholders. The newly-formed real estate investment trust, Starwood Waypoint Residential Trust (“SWAY”), is listed on the New York Stock Exchange (“NYSE”) and trades under the ticker symbol “SWAY.” Our stockholders received one common share of SWAY for every five shares of our common stock held at the close of business on January 24, 2014. As part of the spin-off, we contributed $100 million to the unlevered balance sheet of SWAY to fund its growth and operations. As of January 31, 2014, SWAY held net assets of $1.1 billion. The net assets of SWAY consisted of approximately 7,200 units of single-family homes and residential non-performing mortgage loans as of January 31, 2014. In connection with the spin-off, 40.1 million shares of SWAY were issued. Refer to Note 3 herein for additional information regarding SFR segment financial information.

 

We are organized and conduct our operations to qualify as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, we will generally not be subject to U.S. federal corporate income tax on that portion

 

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Table of Contents

 

of our net income that is distributed to stockholders if we distribute at least 90% of our taxable income to our stockholders by prescribed dates and comply with various other requirements.

 

In connection with the LNR acquisition, we established additional taxable REIT subsidiaries (“TRSs”). TRSs permit us to participate in certain activities from which REITs are generally precluded, as long as these activities meet specific criteria, are conducted within the parameters of certain limitations established by the Code, and are conducted in entities which elect to be treated as taxable subsidiaries under the Code. To the extent these criteria are met, we will continue to maintain our qualification as a REIT.

 

These TRSs engage in various real estate related operations, including special servicing of commercial real estate, originating and securitizing commercial mortgage loans, and investing in entities which engage in real estate related operations. As of March 31, 2014, $799.8 million of the LNR assets were owned by TRS entities. Our TRSs are not consolidated for federal income tax purposes, but are instead taxed as corporations. For financial reporting purposes, a provision for current and deferred taxes is established for the portion of earnings recognized by us with respect to our interest in TRSs.

 

We are organized as a holding company and conduct our business primarily through our various wholly-owned subsidiaries. We are externally managed and advised by SPT Management, LLC (our “Manager”) pursuant to the terms of a management agreement. Our Manager is controlled by Barry Sternlicht, our Chairman and Chief Executive Officer. Our Manager is an affiliate of Starwood Capital Group, a privately-held private equity firm founded and controlled by Mr. Sternlicht.

 

2. Summary of Significant Accounting Policies

 

Balance Sheet Presentation of LNR Variable Interest Entities

 

The acquisition of LNR substantially changed the presentation of our financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). As noted above, LNR operates a finance business that acquires unrated, investment grade and non-investment grade rated CMBS. These securities represent interests in securitization structures (commonly referred to as special purpose entities, or “SPEs”). These SPEs are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. Under GAAP, SPEs typically qualify as variable interest entities (“VIEs”). These are entities that, by design, either (1) lack sufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties, or (2) have equity investors that do not have the ability to make significant decisions relating to the entity’s operations through voting rights, or do not have the obligation to absorb the expected losses, or do not have the right to receive the residual returns of the entity.

 

Because LNR often serves as the special servicer of the trusts in which it invests, consolidation of these structures is required pursuant to GAAP as outlined in detail below. This results in a consolidated balance sheet which presents the gross assets and liabilities of the SPEs. The assets and other instruments held by these SPEs are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the SPEs do not have any recourse to the general credit of any other consolidated entities, nor to us as the consolidator of these SPEs.

 

The SPE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities are eliminated, as is the interest income related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.

 

Please refer to the segment presentation in Note 22 herein for a presentation of the LNR business without consolidation of these VIEs.

 

Basis of Accounting and Principles of Consolidation

 

The accompanying condensed consolidated financial statements include our accounts and those of our consolidated subsidiaries and VIEs. Intercompany amounts have been eliminated in consolidation. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows have been included.

 

These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Form 10-K”), as filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2014 are not necessarily indicative of the operating results for the full year.

 

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Refer to our Form 10-K for a description of our recurring accounting policies. We have included disclosure in this Note 2 regarding principles of consolidation and other accounting policies that are required either (i) to be disclosed quarterly, (ii) that we view as critical, or (iii) became significant since December 31, 2013 due to a corporate action or increase in the significance of the underlying business activity.

 

Variable Interest Entities

 

We evaluate all of our interests in VIEs for consolidation. When our interests are determined to be variable interests, we assess whether we are deemed to be the primary beneficiary of the VIE. The primary beneficiary of a VIE is required to consolidate the VIE. ASC 810, Consolidation, defines the primary beneficiary as the party that has both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant. We consider our variable interests as well as any variable interests of our related parties in making this determination. Where both of these factors are present, we are deemed to be the primary beneficiary and we consolidate the VIE. Where either one of these factors is not present, we are not the primary beneficiary and do not consolidate the VIE.

 

To assess whether we have the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, we consider all facts and circumstances, including our role in establishing the VIE and our ongoing rights and responsibilities. This assessment includes first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE.

 

To assess whether we have the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, we consider all of our economic interests, including debt and equity investments, servicing fees, and other arrangements deemed to be variable interests in the VIE. This assessment requires that we apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by us.

 

Our purchased investment securities include CMBS which are unrated and non-investment grade rated securities issued by CMBS trusts. In certain cases, we may contract to provide special servicing activities for these CMBS trusts, or, as holder of the controlling class, we may have the right to name and remove the special servicer for these trusts. In our role as special servicer, we provide services on defaulted loans within the trusts, such as foreclosure or work-out procedures, as permitted by the underlying contractual agreements. In exchange for these services, we receive a fee. These rights give us the ability to direct activities that could significantly impact the trust’s economic performance. However, in those instances where an unrelated third party has the right to unilaterally remove us as special servicer, we do not have the power to direct activities that most significantly impact the trust’s economic performance. We evaluated all of our positions in such investments for consolidation.

 

For VIEs in which we are determined to be the primary beneficiary, all of the underlying assets, liabilities and equity of the structures are recorded on our books, and the initial investment, along with any associated unrealized holding gains and losses, are eliminated in consolidation. Similarly, the interest income earned from these structures, as well as the fees paid by these trusts to us in our capacity as special servicer, are eliminated in consolidation. Further, an allocable portion of the identified servicing intangible asset associated with the servicing fee streams, and the corresponding allocable amortization or change in fair value of the servicing intangible asset, are also eliminated in consolidation.

 

We perform ongoing reassessments of: (1) whether any entities previously evaluated under the majority voting interest framework have become VIEs, based on certain events, and therefore subject to the VIE consolidation framework, and (2) whether changes in the facts and circumstances regarding our involvement with a VIE causes our consolidation conclusion regarding the VIE to change.

 

We have elected the fair value option in measuring the assets and liabilities of any VIEs we consolidate. Fluctuations in the fair values of the VIE assets and liabilities, along with trust interest income and trust interest and administrative expenses, are presented net in income of consolidated VIEs in our consolidated statements of operations.

 

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Table of Contents

 

Discontinued Operations

 

On January 31, 2014, we completed the spin-off of our SFR segment to our stockholders as discussed in Note 1.  In accordance with Accounting Standards Codification (“ASC”) Topic 205, Presentation of Financial Statements, the results of the SFR segment are presented within discontinued operations in our condensed consolidated statements of operations for the three months ended March 31, 2014 and 2013.

 

Fair Value Option

 

The guidance in ASC 825, Financial Instruments, provides a fair value option election that allows entities to make an irrevocable election of fair value as the initial and subsequent measurement attribute for certain eligible financial assets and liabilities. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The decision to elect the fair value option is determined on an instrument by instrument basis and must be applied to an entire instrument and is irrevocable once elected. Assets and liabilities measured at fair value pursuant to this guidance are required to be reported separately in our consolidated balance sheets from those instruments using another accounting method.

 

We have elected the fair value option for eligible financial assets and liabilities of our consolidated VIEs, loans held-for-sale originated by LNR’s conduit platform, purchased CMBS issued by VIEs we could consolidate in the future and certain investments in marketable equity securities. The fair value elections for VIE and securitization related items were made in order to mitigate accounting mismatches between the carrying value of the instruments and the related assets and liabilities that we consolidate at fair value. The fair value elections for mortgage loans held-for-sale originated by LNR’s conduit platform were made due to the short-term nature of these instruments. The fair value elections for investments in marketable equity securities were made because the shares are listed on an exchange, which allows us to determine the fair value using a quoted price from an active market.

 

Loans Receivable and Provision for Loan Losses

 

In our Lending Segment we purchase and originate commercial real estate debt and related instruments generally to be held as long-term investments at amortized cost. We are required to periodically evaluate each of these loans for possible impairment. Impairment is indicated when it is deemed probable that we will not be able to collect all amounts due according to the contractual terms of the loan. If a loan is determined to be impaired, we write down the loan through a charge to the provision for loan losses. Actual losses, if any, could ultimately differ from these estimates.

 

We perform a quarterly review of our portfolio of loans. In connection with this review, we assess the performance of each loan and assign a risk rating based on several factors including risk of loss, loan-to-value ratio, or LTV, collateral performance, structure, exit plan, and sponsorship. Loans are rated “1” through “5”, from less risk to greater risk in connection with this review.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The most significant and subjective estimate that we make is the projection of cash flows we expect to receive on our loans, investment securities and intangible assets, which has a significant impact on the amounts of interest income, credit losses (if any), and fair values that we record and/or disclose. In addition, the fair value of financial assets and liabilities that are estimated using a discounted cash flows method is significantly impacted by the rates at which we estimate market participants would discount the expected cash flows.

 

Reclassifications

 

As a result of the LNR acquisition, certain items in our condensed consolidated statements of operations and cash flows for the three months ended March 31, 2013 have been reclassified or combined to conform to the current period’s presentation. We removed the “Net interest margin” subtotal from our condensed consolidated statements of operations, with interest income now included in a new “Revenues” subtotal, and interest expense now included within the new “Costs and expenses” subtotal. Additionally, the results from our SFR segment have been reclassified as discontinued operations as a result of the spin-off.  The reclassifications and combinations related to our condensed consolidated statement of cash flows for the three months ended March 31, 2013 had no effect on previously reported totals or subtotals.

 

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Recent Accounting Developments

 

On April 10, 2014 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which requires only those disposals which represent a strategic shift that has or will have a major impact on an entity’s operations or financial results be presented as discontinued operations.  The ASU is effective for annual periods beginning on or after December 15, 2014, and interim periods within those annual periods, and requires prospective application.  We do not expect the application of this ASU to materially impact the Company.

 

3.  Acquisitions and Divestitures

 

SFR Spin-off

 

As described in Note 1, on January 31, 2014, we completed the spin-off of our SFR segment to our stockholders.  The results of operations for the SFR segment are presented within discontinued operations in our condensed consolidated statements of operations for all periods presented. We have no continuing involvement with the SFR segment following the spin-off.  Subsequent to the spin-off, SWAY entered into a management agreement with an affiliate of our Manager. The following table presents the summarized consolidated results of operations for the SFR segment prior to the spin-off, excluding segment allocations (in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Total revenues

 

$

3,876

 

$

1,164

 

Total costs and expenses

 

6,369

 

3,625

 

Loss before other income and income taxes

 

(2,493

)

(2,461

)

Total other income

 

942

 

335

 

Loss before income taxes

 

(1,551

)

(2,126

)

Income tax provision

 

 

(162

)

Net loss

 

$

(1,551

)

$

(2,288

)

 

The following table presents the summarized consolidated balance sheet of the SFR segment as of January 31, 2014, the date of spin-off (in thousands):

 

 

 

January 31, 2014

 

Assets:

 

 

 

Cash and cash equivalents

 

$

111,960

 

Restricted cash

 

189

 

Residential real estate, net

 

812,017

 

Non-performing residential loans

 

211,019

 

Other assets

 

9,498

 

Total Assets

 

$

1,144,683

 

 

 

 

 

Liabilities and Equity

 

 

 

Liabilities:

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

24,346

 

Equity:

 

 

 

Additional paid-in capital

 

1,130,405

 

Accumulated deficit

 

(11,662

)

Total Stockholders’ Equity

 

1,118,743

 

Non-controlling interests in consolidated subsidiaries

 

1,594

 

Total Equity

 

1,120,337

 

Total Liabilities and Equity

 

$

1,144,683

 

 

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Table of Contents

 

LNR Acquisition

 

As described in Note 1, on April 19, 2013, we acquired the equity of LNR for an initial agreed upon purchase price of $859 million, which was reduced for transaction expenses and distributions occurring after September 30, 2012, resulting in cash consideration of approximately $730 million.  We applied the provisions of ASC 805 in accounting for our acquisition of LNR. Refer to Note 3 of our Form 10-K for further discussion of the LNR acquisition including the final purchase price allocation.

 

4. Loans

 

Our loans held-for-investment are accounted for at amortized cost and our loans held-for-sale are accounted for at the lower of cost or fair value, unless we have elected the fair value option. The following tables summarize our investments in mortgages and loans by subordination class as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

March 31, 2014

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(“WAL”)
(years)(2)

 

First mortgages

 

$

2,810,468

 

$

2,866,252

 

5.8

%

4.2

 

Subordinated mortgages(1)

 

501,222

 

536,714

 

8.3

%

4.0

 

Mezzanine loans

 

1,327,714

 

1,336,832

 

11.2

%

3.3

 

Total loans held-for-investment

 

4,639,404

 

4,739,798

 

 

 

 

 

Loans held-for-sale, fair value option elected

 

186,837

 

181,450

 

5.1

%

9.5

 

Loans transferred as secured borrowings

 

143,042

 

143,069

 

5.5

%

3.0

 

Total gross loans

 

4,969,283

 

5,064,317

 

 

 

 

 

Loan loss allowance (loans held-for-investment)

 

(4,481

)

 

 

 

 

 

Total net loans

 

$

4,964,802

 

$

5,064,317

 

 

 

 

 

 

December 31, 2013

 

Carrying
Value

 

Face
Amount

 

Weighted
Average
Coupon

 

Weighted
Average Life
(“WAL”)
(years)(2)

 

First mortgages

 

$

2,616,441

 

$

2,666,875

 

5.6

%

4.3

 

Subordinated mortgages(1)

 

505,533

 

541,817

 

8.7

%

4.2

 

Mezzanine loans

 

1,245,728

 

1,246,841

 

12.2

%

3.7

 

Total loans held-for-investment

 

4,367,702

 

4,455,533

 

 

 

 

 

Loans held-for-sale, fair value option elected

 

206,672

 

209,099

 

5.3

%

9.6

 

Loans transferred as secured borrowings

 

180,414

 

180,483

 

5.4

%

2.9

 

Total gross loans

 

4,754,788

 

4,845,115

 

 

 

 

 

Loan loss allowance (loans held-for-investment)

 

(3,984

)

 

 

 

 

 

Total net loans

 

$

4,750,804

 

$

4,845,115

 

 

 

 

 

 


(1)                                 Subordinated mortgages include (i) subordinated mortgages that we retain after having sold first mortgage positions related to the same collateral and (ii) B-Notes.

 

(2)                                 Represents the WAL of each respective group of loans as of the respective balance sheet date. The WAL of each individual loan is calculated as a fraction, the numerator of which is the sum of the timing (in years) of each expected future principal payment multiplied by the balance of the respective payment, and with a denominator equal to the sum of the expected principal payments using the contractually extended maturity dates of the assets. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the loan.

 

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Table of Contents

 

As of March 31, 2014, approximately $3.6 billion, or 71.8%, of the loans were variable rate and paid interest principally at LIBOR plus a weighted-average spread of 5.18%. The following table summarizes our investments in floating rate loans (amounts in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

Index

 

Base Rate

 

Carrying
Value

 

Base Rate

 

Carrying
Value

 

1 Month LIBOR

 

0.1520%

 

$

630,005

 

0.1677%

 

$

590,444

 

LIBOR Floor

 

0.19% - 3.00%(1)

 

2,937,015

 

0.19% - 3.00%(1)

 

2,641,162

 

U.S. Prime Rate

 

3.25%

 

2,197

 

3.25%

 

2,226

 

Total

 

 

 

$

3,569,217

 

 

 

$

3,233,832

 

 


(1)                                 The weighted-average LIBOR Floor was 0.41% and 0.49% as of March 31, 2014 and December 31, 2013, respectively.

 

As of March 31, 2014, the risk ratings for loans subject to our rating system, which is described in our Form 10-K and excludes loans on the cost recovery method and loans for which the fair value option has been elected, by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification

 

 

 

 

 

Loans Held-For-Investment

 

 

 

Loans

 

 

 

Risk
Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Cost
Recovery
Loans

 

Loans Held-
For-Sale

 

Transferred
As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

100,691

 

104,092

 

226,689

 

 

 

12,994

 

444,466

 

3

 

2,552,430

 

360,398

 

986,067

 

 

 

130,048

 

4,028,943

 

4

 

147,063

 

36,732

 

114,958

 

 

 

 

298,753

 

5

 

 

 

 

 

 

 

 

N/A

 

2,219

 

 

 

8,065

 

186,837

 

 

197,121

 

 

 

$

2,802,403

 

$

501,222

 

$

1,327,714

 

$

8,065

 

$

186,837

 

$

143,042

 

$

4,969,283

 

 

As of December 31, 2013, the risk ratings for loans subject to our rating system by class of loan were as follows (amounts in thousands):

 

 

 

Balance Sheet Classification

 

 

 

 

 

Loans Held-For-Investment

 

 

 

Loans

 

 

 

Risk
Rating
Category

 

First
Mortgages

 

Subordinated
Mortgages

 

Mezzanine
Loans

 

Cost
Recovery
Loans

 

Loans Held-
For-Sale

 

Transferred
As Secured
Borrowings

 

Total

 

1

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

2

 

94,981

 

103,369

 

153,119

 

 

 

13,022

 

364,491

 

3

 

2,354,692

 

370,446

 

1,012,674

 

 

 

167,392

 

3,905,204

 

4

 

153,987

 

31,718

 

79,935

 

 

 

 

265,640

 

5

 

 

 

 

 

 

 

 

N/A

 

 

 

 

12,781

 

206,672

 

 

219,453

 

 

 

$

2,603,660

 

$

505,533

 

$

1,245,728

 

$

12,781

 

$

206,672

 

$

180,414

 

$

4,754,788

 

 

After completing our impairment evaluation process as described in our Form 10-K, we concluded that no impairment charges were required on any individual loans held-for-investment as of March 31, 2014 or December 31, 2013. As of March 31, 2014, approximately $57.8 million of our loans held-for-investment were in default, approximately $8.0 million of which are within the LNR Segment and were acquired as non-performing loans prior to the April 19, 2013 acquisition.  The remaining $49.8 million of the defaulted loan balance is comprised of a single mezzanine loan within the Lending Segment.  The senior loan was in technical default as of March 31, 2014 due to a covenant breach, which caused our mezzanine loan to be in default.  The loan is in the process of being refinanced, with a substantial equity investment by the borrower.  No lender concessions are expected to be granted in connection with the refinancing. Additionally, none of our held-for-sale loans where we have elected the fair value option was 90 days or more past due or on nonaccrual status.

 

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In accordance with our policies, we record an allowance for loan losses equal to (i) 1.5% of the aggregate carrying amount of loans rated as a “4,” plus (ii) 5% of the aggregate carrying amount of loans rated as a “5.” These groups accounted for 6.0% and 5.6% of our loan portfolio as of March 31, 2014 and December 31, 2013, respectively.  The following table presents the activity in our allowance for loan losses (amounts in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Allowance for loan losses at January 1

 

$

3,984

 

$

2,061

 

Provision for loan losses

 

497

 

30

 

Charge-offs

 

 

 

Recoveries

 

 

 

Allowance for loan losses at March 31

 

$

4,481

 

$

2,091

 

Recorded investment in loans related to the allowance for loan loss

 

$

298,753

 

$

112,573

 

 

The activity in our loan portfolio was as follows (amounts in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Balance at January 1

 

$

4,750,804

 

$

3,000,335

 

Acquisitions/originations/additional funding

 

981,762

 

129,817

 

Capitalized interest(1)

 

8,656

 

1,611

 

Basis of loans sold(2)

 

(448,317

)

(44,631

)

Loan maturities/principal repayments

 

(353,934

)

(93,651

)

Discount accretion/premium amortization

 

1,806

 

7,632

 

Changes in fair value

 

20,893

 

 

Unrealized foreign currency remeasurement gain (loss)

 

3,629

 

(6,141

)

Loan loss allowance

 

(497

)

(30

)

Balance at March 31

 

$

4,964,802

 

$

2,994,942

 

 


(1)         Represents accrued interest income on loans whose terms do not require current payment of interest.

(2)         See Note 10 for additional disclosure on these transactions.

 

5. Investment Securities

 

Investment securities were comprised of the following as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Carrying Value as of

 

 

 

March 31, 2014

 

December 31, 2013

 

RMBS, available-for-sale

 

$

291,217

 

$

296,236

 

Single-borrower CMBS, available-for-sale

 

113,477

 

114,346

 

CMBS, fair value option (1)

 

564,818

 

550,282

 

Held-to-maturity (“HTM”) securities

 

369,152

 

368,318

 

Equity security, fair value option

 

15,115

 

15,247

 

Subtotal - Investment securities

 

1,353,779

 

1,344,429

 

VIE eliminations (1)

 

(430,694

)

(409,322

)

Total investment securities

 

$

923,085

 

$

935,107

 

 


(1)         Certain fair value option CMBS are eliminated in consolidation against VIE liabilities pursuant to ASC 810.

 

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Purchases, sales and principal collections for all investment securities were as follows (amounts in thousands):

 

 

 

Available-for-sale

 

CMBS, fair

 

HTM

 

Equity

 

 

 

 

 

RMBS

 

CMBS

 

value option

 

Securities

 

Security

 

Total

 

Three Months ended March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

$

 

$

 

$

9,890

 

$

 

$

 

$

9,890

 

Sales

 

9,309

 

 

18,574

 

 

 

27,883

 

Principal collections

 

7,819

 

408

 

 

 

 

8,227

 

Three Months ended March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

 

 

37,190

 

 

37,190

 

Sales

 

12,711

 

206,608

(1)

 

 

6,769

 

226,088

 

Principal collections

 

16,868

 

4,858

 

 

 

 

21,726

 

 


(1)         Settlement occurred subsequent to March 31, 2013.  We account for all investment securities transactions on a trade date basis.

 

RMBS and Single-borrower CMBS, Available-for-Sale

 

With the exception of one CMBS classified as HTM, the Company classified all of its RMBS and CMBS investments where the fair value option has not been elected as available-for-sale as of March 31, 2014 and December 31, 2013. These RMBS and CMBS are reported at fair value in the balance sheet with changes in fair value recorded in accumulated other comprehensive income (“AOCI”).

 

The tables below summarize various attributes of our investments in available-for-sale RMBS and single-borrower CMBS where the fair value option has not been elected as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

 

 

 

 

 

 

Unrealized Gains or (Losses)
Recognized in AOCI

 

 

 

 

 

Purchase
Amortized
Cost

 

Credit
OTTI

 

Recorded
Amortized
Cost

 

Non-Credit
OTTI

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Net
Fair Value
Adjustment

 

Fair Value

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMBS

 

$

243,354

 

$

(10,342

)

$

233,012

 

$

(979

)

$

59,419

 

$

(235

)

$

58,205

 

$

291,217

 

Single-borrower CMBS

 

100,980

 

 

100,980

 

 

12,497

 

 

12,497

 

113,477

 

Total

 

$

344,334

 

$

(10,342

)

$

333,992

 

$

(979

)

$

71,916

 

$

(235

)

$

70,702

 

$

404,694

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMBS

 

$

253,912

 

$

(11,134

)

$

242,778

 

$

(55

)

$

55,154

 

$

(1,641

)

$

53,458

 

$

296,236

 

Single-borrower CMBS

 

100,687

 

 

100,687

 

 

13,659

 

 

13,659

 

114,346

 

Total

 

$

354,599

 

$

(11,134

)

$

343,465

 

$

(55

)

$

68,813

 

$

(1,641

)

$

67,117

 

$

410,582

 

 

 

 

Weighted Average
Coupon(1)

 

Weighted Average
Rating
(Standard & Poor’s)

 

WAL (Years)(3)

 

March 31, 2014

 

 

 

 

 

 

 

RMBS

 

1.0

%

B-

 

7.8

 

Single-borrower CMBS

 

11.5

%

BB+

(2)

4.0

 

December 31, 2013

 

 

 

 

 

 

 

RMBS

 

1.0

%

B-

 

6.8

 

Single-borrower CMBS

 

11.5

%

BB+

(2)

5.9

 

 


(1)                                 Calculated using the March 31, 2014 and December 31, 2013 one-month LIBOR rate of 0.152% and 0.168%, respectively, for floating rate securities.

 

(2)                                 As of March 31, 2014 and December 31, 2013, approximately 99.1% and 98.8%, respectively, of the CMBS securities were rated BB+.

 

(3)                                 Represents the WAL of each respective group of securities calculated as of the respective balance sheet date. The WAL of each individual security or loan is calculated as a fraction, the numerator of which is the sum of the timing

 

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(in years) of each expected future principal payment multiplied by the balance of the respective payment, and with a denominator equal to the sum of the expected principal payments using the contractually extended maturity dates of the assets. Assumptions for the calculation of the WAL are adjusted as necessary for changes in projected principal repayments and/or maturity dates of the security.

 

As of March 31, 2014, $1.0 million, or 0.9%, of the single-borrower CMBS were variable rate. As of December 31, 2013, $1.3 million, or 1.2%, of the single-borrower CMBS were variable rate. As of March 31, 2014, approximately $252.1 million, or 86.6%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.38%. As of December 31, 2013, approximately $256.1 million, or 86.5%, of the RMBS were variable rate and paid interest at LIBOR plus a weighted average spread of 0.37%. We purchased all of the RMBS at a discount that will be accreted into income over the expected remaining life of the security. The majority of the income from this strategy is earned from the accretion of these discounts.

 

The following table contains a reconciliation of aggregate principal balance to amortized cost for our RMBS and single-borrower CMBS as of March 31, 2014 and December 31, 2013, excluding CMBS where we have elected the fair value option (amounts in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

RMBS

 

CMBS

 

RMBS

 

CMBS

 

Principal balance

 

$

388,066

 

$

100,980

 

$

414,020

 

$

100,687

 

Accretable yield

 

(99,622

)

 

(101,046

)

 

Non-accretable difference

 

(55,432

)

 

(70,196

)

 

Total discount

 

(155,054

)

 

(171,242

)

 

Amortized cost

 

$

233,012

 

$

100,980

 

$

242,778

 

$

100,687

 

 

The principal balance of credit deteriorated RMBS was $300.7 million and $320.4 million as of March 31, 2014 and December 31, 2013, respectively. Accretable yield related to these securities totaled $79.3 million and $78.3 million as of March 31, 2014 and December 31, 2013, respectively.

 

The following table discloses the changes to accretable yield and non-accretable difference for our RMBS and single-borrower CMBS during the three months ended March 31, 2014 and 2013, excluding CMBS where we have elected the fair value option (amounts in thousands):

 

 

 

Accretable Yield

 

Non-Accretable
Difference

 

 

 

RMBS

 

CMBS

 

RMBS

 

CMBS

 

Balance as of January 1, 2014

 

$

101,046

 

$

 

$

70,196

 

$

 

Accretion of discount

 

(6,564

)

 

 

 

Principal write-downs

 

 

 

(366

)

 

Purchases

 

 

 

 

 

Sales

 

(1,962

)

 

(7,509

)

 

OTTI

 

213

 

 

 

 

Transfer to/from non-accretable difference

 

6,889

 

 

(6,889

)

 

Balance as of March 31, 2014

 

$

99,622

 

$

 

$

55,432

 

$

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2013

 

$

108,486

 

$

21,511

 

$

97,605

 

$

 

Accretion of discount

 

(6,151

)

(3,029

)

 

 

Principal write-downs

 

 

 

(496

)

 

Purchases

 

 

 

 

 

Sales

 

(2,418

)

(9,873

)

(2,038

)

 

OTTI

 

42

 

 

 

 

Transfer to/from non-accretable difference

 

(1,002

)

 

1,002

 

 

Balance as of March 31, 2013

 

$

98,957

 

$

8,609

 

$

96,073

 

$

 

 

Subject to certain limitations on durations, we have allocated an amount to invest in RMBS that cannot exceed 10% of our total assets excluding LNR VIEs. We have engaged a third party manager who specializes in RMBS to execute the trading of RMBS, the cost of which was $0.6 million for each of the three months ended March 31, 2014 and 2013, which has been recorded as management fees in the accompanying condensed consolidated statements of operations.

 

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The following table presents the gross unrealized losses and estimated fair value of the available-for-sale securities (i) where we have not elected the fair value option, (ii) that were in an unrealized loss position as of March 31, 2014 and December 31, 2013, and (iii) for which OTTIs (full or partial) have not been recognized in earnings (amounts in thousands):

 

 

 

Estimated Fair Value

 

Unrealized Losses

 

 

 

Securities with a
loss less than
12 months

 

Securities with a
loss greater than
12 months

 

Securities with a
loss less than
12 months

 

Securities with a
loss greater than
12 months

 

As of March 31, 2014

 

 

 

 

 

 

 

 

 

RMBS

 

$

20,799

 

$

799

 

$

(1,040

)

$

(174

)

Single-borrower CMBS

 

 

 

 

 

Total

 

$

20,799

 

$

799

 

$

(1,040

)

$

(174

)

As of December 31, 2013

 

 

 

 

 

 

 

 

 

RMBS

 

$

26,344

 

$

1,809

 

$

(1,444

)

$

(252

)

Single-borrower CMBS

 

 

 

 

 

Total

 

$

26,344

 

$

1,809

 

$

(1,444

)

$

(252

)

 

As of March 31, 2014, there were six securities with unrealized losses reflected in the table above. After evaluating each security and recording adjustments, as necessary, for other-than-temporary impairments, the remaining unrealized losses reflected above were not considered to represent other-than-temporary impairments. We considered a number of factors in reaching this conclusion, including that we did not intend to sell any individual security, it was not considered more likely than not that we would be forced to sell any individual security prior to recovering our amortized cost, and there were no material credit events that would have caused us to otherwise conclude that we would not recover our cost. Credit losses, which represent most of the other-than-temporary impairments we record, are calculated by comparing (i) the estimated future cash flows of each security discounted at the yield determined as of the initial acquisition date or, if since revised, as of the last date previously revised, to (ii) our amortized cost basis. Significant judgment is used in projecting cash flows for our non-agency RMBS. As a result, actual income and/or impairments could be materially different from what is currently projected and/or reported.

 

CMBS, Fair Value Option

 

As discussed in the “Fair Value Option” section of Note 2 herein, we elect the fair value option for LNR’s CMBS in an effort to eliminate accounting mismatches resulting from the current or potential consolidation of securitization VIEs. As of March 31, 2014, the fair value and unpaid principal balance of CMBS where we have elected the fair value option, before consolidation of securitization VIEs, were $564.8 million and $3.9 billion, respectively. These balances represent our economic interests in these assets. However, as a result of our consolidation of securitization VIEs, the vast majority of this fair value ($430.7 million at March 31, 2014) is eliminated against VIE liabilities before arriving at our GAAP balance for fair value option CMBS. During the three months ended March 31, 2014, we purchased $44.7 million of CMBS for which we elected the fair value option. Due to our consolidation of securitization VIEs, $34.8 million of this amount is reflected as repayment of debt of consolidated VIEs in our condensed consolidated statement of cash flows.

 

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As of March 31, 2014 and December 31, 2013, none of our CMBS where we have elected the fair value option were variable rate. The table below summarizes various attributes of our investment in fair value option CMBS as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Weighted
Average
Coupon

 

Weighted
Average
Rating
(Standard &
Poor’s)

 

WAL
(Years)(1)

 

March 31, 2014

 

 

 

 

 

 

 

CMBS, fair value option

 

5.4

%

C

(2)

5.6

 

December 31, 2013

 

 

 

 

 

 

 

CMBS, fair value option

 

5.4

%

D

(2)

4.4

 

 


(1)                                 The WAL of each security is calculated based on the period of time over which we expect to receive principal cash flows. Expected principal cash flows are based on contractual payments net of expected losses.

 

(2)                                 As of March 31, 2014 and December 31, 2013, includes $53.8 million and $55.5 million, respectively, in fair value option CMBS that are not rated but assigned a rating weight one level lower than NR for purposes of this calculation. As of March 31, 2014 and December 31, 2013, the remaining $80.3 million and $85.4 million, respectively, in fair value option CMBS had a weighted average rating of CC and C, respectively.

 

HTM Securities

 

The table below summarizes various attributes of our investments in HTM securities as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Net Carrying
Amount
(Amortized
Cost)

 

Gross
Unrealized
Holding
Gains

 

Gross
Unrealized
Holding
Losses

 

Fair Value

 

March 31, 2014

 

 

 

 

 

 

 

 

 

Preferred interests

 

$

284,991

 

$

 

$

(754

)

$

284,237

 

CMBS

 

84,161

 

 

(587

)

83,574

 

Total

 

$

369,152

 

$

 

$

(1,341

)

$

367,811

 

December 31, 2013

 

 

 

 

 

 

 

 

 

Preferred interests

 

$

284,087

 

$

135

 

$

 

$

284,222

 

CMBS

 

84,231

 

 

 

84,231

 

Total

 

$

368,318

 

$

135

 

$

 

$

368,453

 

 

During 2013, we originated two preferred equity interests of $246.1 million and $37.2 million, respectively, in limited liability companies that own commercial real estate. These preferred equity interests mature in December 2018 and October 2014, respectively.  During 2013, we also purchased a CMBS security with a face value and purchase price of $84.1 million, which we expect to hold to maturity. The stated maturity of this security is November 2016.

 

Equity Security, Fair Value Option

 

During 2012, we acquired 9,140,000 ordinary shares from a related-party (approximately a 4% interest) in Starwood European Real Estate Finance Limited (“SEREF”), a debt fund that is externally managed by an affiliate of our Manager and is listed on the London Stock Exchange. We have elected to report the investment using the fair value option because the shares are listed on an exchange, which allows us to determine the fair value using a quoted price from an active market, and also due to potential lags in reporting resulting from differences in the respective regulatory requirements. The fair value of the investment remeasured in USD was $15.1 million and $15.2 million as of March 31, 2014 and December 31, 2013, respectively.

 

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6. Investment in Unconsolidated Entities

 

The below table summarizes our investments in unconsolidated entities as of March 31, 2014 and December 31, 2013 (dollar amounts in thousands):

 

 

 

Participation /

 

Carrying value as of

 

Carrying value over (under)
equity in net assets as of

 

 

 

Ownership %(1)

 

March 31, 2014

 

December 31, 2013

 

March 31, 2014(2)

 

Equity method:

 

 

 

 

 

 

 

 

 

Investor entity which owns equity interests in two real estate services providers

 

50%

 

$

19,449

 

$

19,371

 

$

 

Small balance bridge loan financing venture

 

50%

 

25,947

 

26,121

 

 

European investment fund

 

50%

 

9,409

 

23,779

 

(4,051

)

Mezzanine loan venture

 

49%

 

23,508

 

23,676

 

 

Healthcare bridge loan venture

 

various

 

10,365

 

14,163

 

 

Various

 

25% - 50%

 

4,577

 

4,371

 

 

 

 

 

 

93,255

 

111,481

 

$

(4,051

)

Cost method:

 

 

 

 

 

 

 

 

 

Loan servicing venture

 

4% - 6%

 

8,014

 

8,014

 

 

 

Various

 

2% - 10%

 

3,251

 

3,459

 

 

 

 

 

 

 

11,265

 

11,473

 

 

 

 

 

 

 

$

104,520

 

$

122,954

 

 

 

 

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(1)                                 None of these investments are publicly traded and therefore quoted market prices are not available.

 

(2)                                 Differences between the carrying value of our investment and the underlying equity in net assets of the investee are accounted for as if the investee were a consolidated entity in accordance with ASC 323, Investments—Equity Method and Joint Ventures.

 

7. Goodwill and Intangible Assets

 

Goodwill

 

Goodwill at March 31, 2014 and December 31, 2013 represents the excess of consideration transferred over the fair value of net assets of LNR acquired on April 19, 2013. The goodwill recognized is attributable to value embedded in LNR’s existing platform, which includes an international network of commercial real estate asset managers, work-out specialists, underwriters and administrative support professionals as well as proprietary historical performance data on commercial real estate assets.

 

Servicing Rights Intangibles

 

In connection with the LNR acquisition, we identified domestic and European servicing rights that existed at the purchase date, based upon the expected future cash flows of the associated servicing contracts. All of our servicing fees are specified by these Pooling and Servicing Agreements. At March 31, 2014 and December 31, 2013, the balance of the domestic servicing intangible was net of $77.0 million and $80.6 million, respectively, that was eliminated in consolidation pursuant to ASC 810 against VIE assets in connection with our consolidation of securitization VIEs. Before VIE consolidation, as of March 31, 2014 and December 31, 2013 the domestic servicing intangible had a balance of $221.9 million and $230.7 million, respectively, which represents our economic interest in this asset.

 

The table below presents information about our GAAP servicing intangibles for the three months ended March 31, 2014 (in thousands):

 

Domestic servicing rights, at fair value

 

 

 

Fair value at January 1, 2014

 

$

150,149

 

Changes in fair value due to changes in inputs and assumptions

 

(5,251

)

Fair value at March 31, 2014

 

144,898

 

European servicing rights

 

 

 

Net carrying amount at January 1, 2014 (fair value of $29.3 million)

 

27,024

 

Foreign exchange gain

 

145

 

Amortization

 

(4,011

)

Net carrying value at March 31, 2014 (fair value of $24.4 million)

 

23,158

 

Total servicing rights at March 31, 2014

 

$

168,056

 

 

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8. Secured Financing Agreements

 

The following table is a summary of our secured financing agreements in place as of March 31, 2014 and December 31, 2013 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pledged
Asset

 

Maximum

 

Carrying Value at

 

 

 

Facility 
Type

 

Revolver

 

Eligible 
Assets

 

Current 
Maturity

 

Extended 
Maturity(a)

 

Pricing

 

Carrying 
Value

 

Facility 
Size

 

March 31, 2014

 

December 31, 
2013

 

Lender 1 Repo 1

 

Repurchase

 

Yes

 

Identified Loans and CMBS

 

(b)

 

(b)

 

LIBOR + 1.85% to 5.25%

 

$

 1,257,467

 

$

 1,000,000

 

$

 810,081

 

$

 449,323

 

Lender 1 Repo 2

 

Repurchase

 

Yes

 

Identified RMBS

 

(c)

 

N/A

 

LIBOR + 1.90%

 

267,464

 

175,000

 

159,427

 

127,943

 

Lender 1 Repo 3

 

Repurchase

 

No

 

Identified Loans

 

Dec 2014

 

Dec 2016

 

LIBOR + 2.75%

 

209,427

 

153,299

 

153,299

 

154,133

 

Lender 2 Repo 1

 

Repurchase

 

Yes

 

Identified Loans

 

Oct 2015

 

Oct 2018

 

LIBOR + 2.00% to 2.75%

 

211,684

 

225,000

 

136,018

 

100,886

 

Lender 3 Repo 1

 

Repurchase

 

No

 

Identified Loans

 

Jul 2015

 

Jul 2017

 

LIBOR + 3.00%

 

76,847

 

49,862

 

49,862

 

50,871

 

Conduit I

 

Repurchase

 

Yes

 

Identified Loans

 

Sep 2014

 

Sep 2014

 

LIBOR + 2.20%

 

112,720

 

250,000

 

80,633

 

129,843

 

Conduit II

 

Repurchase

 

Yes

 

Identified Loans

 

Nov 2014

 

Nov 2014

 

LIBOR + 2.10%

 

37,307

 

150,000

 

27,900

 

 

Lender 4 Repo 1

 

Repurchase

 

No

 

Identified Loans

 

Oct 2015

 

Oct 2017

 

LIBOR + 2.60%

 

444,793

 

349,902

 

349,902

 

347,697

 

Lender 5 Repo 1

 

Repurchase

 

No

 

Identified CMBS

 

Dec 2014

 

Dec 2014

 

LIBOR + 2.00%

 

84,161

 

58,467

 

58,467

 

58,467

 

Borrowing Base

 

Bank Credit Facility

 

Yes

 

Identified Loans

 

Sep 2015

 

Sep 2017

 

LIBOR + 3.25%(d)

 

869,527

 

250,000

 

107,769

 

169,104

 

Term Loan

 

Syndicated Facility

 

No

 

Specifically Identified Assets

 

Apr 2020

 

Apr 2020

 

LIBOR + 2.75%(d)

 

2,568,446

 

670,116

 

667,704

(e)

669,293

(e)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

6,139,843

 

$

3,331,646

 

$

2,601,062

 

$

2,257,560

 

 


(a)                                 Subject to certain conditions as defined in the respective facility agreement.

(b)                                 Maturity date for borrowings collateralized by loans of January 2017 before extension options and January 2019 assuming initial extension options.  Maturity date for borrowings collateralized by CMBS of January 2015 before extension options and January 2016 assuming initial extension options.

(c)                                  The date that is 180 days after the buyer delivers notice to seller, subject to a maximum date of March 13, 2015.

(d)                                 Subject to borrower’s option to choose alternative benchmark based rates pursuant to the terms of the credit agreement. The Term Loan is also subject to a 75 basis point floor.

(e)                                  Term loan outstanding balance is net of $2.4 million and $2.5 million of unamortized discount as of March 31, 2014 and December 31, 2013.

 

In January 2014, we amended the Lender 1 Repo 1 facility to (i) upsize available borrowings to $1.0 billion from $550 million; (ii) extend the maturity date for loan collateral to January 2019 and for CMBS collateral to January 2016, each from August 2014, and each assuming initial extension options; (iii) allow for up to four additional one-year extension options with respect to any loan collateral that remains financed at maturity, in an effort to match the term of the maturity dates of these assets; (iv) reduce pricing and debt-yield thresholds for purchased assets; and (v) amend certain financial covenants to contemplate the spin-off of the SFR segment.  STWD guarantees certain of the obligations of the consolidated subsidiary, which is the borrower under the repurchase agreement, up to a maximum liability of either 25% or 100% of the then-currently outstanding repurchase price of purchased assets, depending upon the type of asset being financed.

 

Our secured financing agreements contain certain financial tests and covenants. As of March 31, 2014, we were in compliance with all such covenants.

 

The following table sets forth our five-year principal repayments schedule for the secured financings, assuming no defaults or expected extensions and excluding the loans transferred as secured borrowings. Our credit facilities generally require principal to be paid down prior to the facilities’ respective maturities if and when we receive principal payments on, or sell, the investment collateral that we have pledged. The amount reflected in each period includes principal repayments on our credit facilities that would be required if (i) we received the repayments that we expect to receive on the investments that have been pledged as collateral under the credit facilities, as applicable, and (ii) the credit facilities that are expected to have amounts outstanding at their current maturity dates are extended where extension options are available to us (amounts in thousands):

 

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2014 (remainder of)

 

$

211,941

 

2015

 

194,927

 

2016

 

373,884

 

2017

 

627,863

 

2018

 

186,817

 

Thereafter(1)

 

1,008,041

 

Total

 

$

2,603,473

 

 


(1)                                 Principal paydown of the Term Loan through 2020 excludes $2.4 million of discount amortization.

 

 

Secured financing maturities for 2014 primarily relate to $80.6 million on the Conduit I facility, $58.5 million on the Lender 5 Repo 1 facility, $27.9 million on the Conduit II facility, and $25.7 million on the Lender 1 Repo 3 facility.

 

As of March 31, 2014 and December 31, 2013, we had approximately $27.1 million and $22.5 million, respectively, of deferred financing costs from secured financing agreements, net of amortization, which is included in other assets on our condensed consolidated balance sheets. For the three months ended March 31, 2014 and 2013, approximately $2.9 million, and $3.2 million, respectively, of amortization was included in interest expense on our condensed consolidated statements of operations.

 

9. Convertible Senior Notes

 

On February 15, 2013, we issued $600.0 million of 4.55% Convertible Senior Notes due 2018 (the “2018 Notes”). On July 3, 2013, we issued $460.0 million of 4.00% Convertible Senior Notes due 2019 (the “2019 Notes”). The following summarizes the unsecured convertible senior notes (collectively, the “Convertible Notes”) outstanding as of March 31, 2014 (amounts in thousands, except rates):

 

 

 

Principal
Amount

 

Coupon
Rate

 

Effective
Rate(1)

 

Conversion
Rate(2)

 

Maturity
Date

 

Remaining
Period of
Amortization

 

2018 Notes

 

$

600,000

 

4.55

%

6.08

%

44.4112

 

3/1/2018

 

3.9 years

 

2019 Notes

 

$

460,000

 

4.00

%

5.37

%

47.3282

 

1/15/2019

 

4.8 years

 

 

 

 

As of
March 31, 2014

 

As of
December 31, 2013

 

Total principal

 

$

1,060,000

 

$

1,060,000

 

Net unamortized discount

 

(59,161

)

(62,149

)

Carrying amount of debt components

 

$

1,000,839

 

$

997,851

 

Carrying amount of conversion option equity components recorded in additional paid-in capital

 

$

48,502

 

$

48,502

 

 


(1)                                 Effective rate includes the effects of underwriter purchase discount and the adjustment for the conversion option, the value of which reduced the initial liability and was recorded in additional paid-in-capital.

 

(2)                                 The conversion rate represents the number of common shares issuable per $1,000 principal amount of Convertible Notes converted, as adjusted in accordance with the applicable indentures as a result of the spin-off of the SFR segment. The if-converted value of the 2018 Notes exceeded their principal amount by $28.6 million at March 31, 2014 since the closing market price of the Company’s common stock of $23.59 per share exceeded the implicit conversion price of $22.52 per share. The if-converted value of the 2019 Notes exceeded their principal amount by $53.6 million at March 31, 2014 since the closing market price of $23.59 per share exceeded the implicit conversion price of $21.13 per share for the 2019 Notes.  The Company has asserted its intent and ability to settle the principal amount of the Convertible Notes in cash.  As a result, conversion of this principal amount, totaling 45.2 million shares, was not included in the computation of diluted earnings per share (“EPS”).  However, the conversion spread value, representing 3.2 million shares, was included in the computation of diluted EPS.  See further discussion at Note 16.

 

As of March 31, 2014 and December 31, 2013, we had approximately $1.5 million and $1.6 million, respectively, of deferred financing costs from our Convertible Senior Notes, net of amortization, which is included in other assets on our condensed consolidated balance sheets.

 

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Conditions for Conversion

 

Prior to September 1, 2017 for the 2018 Notes and July 15, 2018 for the 2019 Notes, the Convertible Notes will be convertible only upon satisfaction of one or more of the following conditions: (1) the closing market price of the Company’s common stock is at least 130% of the conversion price of the respective Convertible Notes for at least 20 out of 30 trading days prior to the end of the preceding fiscal quarter, (2) the trading price of the Convertible Notes is less than 98% of the product of (i) the conversion rate and (ii) the closing price of the Company’s common stock during any five consecutive trading day period, (3) the Company issues certain equity instruments at less than the 10-day average closing market price of its common stock or the per-share value of certain distributions exceeds the market price of the Company’s common stock by more than 10% or (4) other specified corporate events (significant consolidation, sale, merger, share exchange, fundamental change, etc.) occur.

 

On or after September 1, 2017 for the 2018 Notes and July 15, 2018 for the 2019 Notes, holders may convert each of their notes at the applicable conversion rate at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date.

 

Impact of Spin-off on Convertible Senior Notes

 

As described in Note 1, on January 31, 2014, the Company distributed all of its interest in the SFR segment to the Company’s stockholders of record as of January 24, 2014.  As the per-share value of the of the distribution was expected to exceed 10% of the last reported market price of the Company’s common stock on the trading day prior to the announcement for such distribution, holders of the Convertible Notes were eligible to surrender their notes for conversion at any time during the period beginning November 26, 2013 (the 45th trading day immediately prior to the scheduled ex-dividend date for the distribution) and ending on the close of the business day immediately preceding February 3, 2014, the ex-dividend date for such distribution.  During this period, the Company received notices of conversion totaling $19 thousand and $3 thousand in principal for the 2018 Notes and 2019 Notes, respectively.  The cash settlement of these conversions occurred in April 2014.

 

Due to the distribution, the quarterly dividend threshold amounts for the Convertible Notes were adjusted to $0.3548 and $0.3710 (from $0.44 and $0.46) per common share for the 2018 Notes and 2019 Notes, respectively, effective February 3, 2014.

 

Refer to Note 11 to the consolidated financial statements included in our Form 10-K for further discussion regarding our accounting for the convertible senior notes.

 

10. Loan Securitization/Sale Activities

 

As described below, we regularly sell loans and notes under various strategies. We evaluate such sales as to whether they meet the criteria for treatment as a sale—legal isolation, ability of transferee to pledge or exchange the transferred assets without constraint, and transfer of control.

 

Within LNR, we originate commercial mortgage loans with the intent to sell these mortgage loans to SPEs for the purposes of securitization. These SPEs then issue CMBS that are collateralized in part by these assets, as well as other assets transferred to the SPE. In certain instances, we retain a subordinated interest in the SPE and serve as special servicer for the SPE. During the three months ended March 31, 2014, we sold $289.4 million par value of loans held-for-sale from our conduit platform for their fair values of $302.5 million. During the three months ended March 31, 2014, the sale proceeds were used in part to repay $217.0 million of the outstanding balance of the repurchase agreements associated with these loans.

 

Within the Lending Segment (refer to Note 22), we originate or acquire loans and then subsequently sell a senior portion, which can be represented in various forms including first mortgages, A-Notes and senior participations. Typically, our motivation for entering into these transactions is to effectively create leverage on the subordinated position that we will retain and hold for investment. The following table summarizes our loans sold and loans transferred as secured borrowings by the Lending Segment net of expenses (in thousands):

 

 

 

Loan Transfers Accounted
for as Sales

 

Loan Transfers
Accounted for as Secured
Borrowings

 

 

 

Face Amount

 

Proceeds

 

Face Amount

 

Proceeds

 

For the three months ended March 31,

 

 

 

 

 

 

 

 

 

2014

 

$

147,884

 

$

146,400

 

$

 

$

 

2013

 

44,531

 

44,631

 

 

 

 

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11. Derivatives and Hedging Activity

 

Risk Management Objective of Using Derivatives

 

We are exposed to certain risks arising from both our business operations and economic conditions. Refer to Note 13 to the consolidated financial statements included in our Form 10-K for further discussion of our risk management objectives and policies.

 

Designated Hedges

 

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

In connection with our repurchase agreements, we have entered into eight outstanding interest rate swaps that have been designated as cash flow hedges of the interest rate risk associated with forecasted interest payments. As of March 31, 2014, the aggregate notional of our interest rate swaps designated as cash flow hedges of interest rate risk totaled $198.9 million. Under these agreements, we will pay fixed monthly coupons at fixed rates ranging from 0.56% to 2.23% of the notional amount to the counterparty and receive floating rate LIBOR. Our interest rate swaps designated as cash flow hedges of interest rate risk have maturities ranging from May 2014 to May 2021.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2014 and 2013 we did not recognize any hedge ineffectiveness in earnings.

 

Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the associated variable-rate debt. Over the next twelve months, we estimate that an additional $1.2 million will be reclassified as an increase to interest expense. We are hedging our exposure to the variability in future cash flows for forecasted transactions over a maximum period of 86 months.

 

Non-designated Hedges

 

Derivatives not designated as hedges are derivatives that do not meet the criteria for hedge accounting under GAAP or for which we have not elected to designate as hedges. We do not use these derivatives for speculative purposes but instead they are used to manage our exposure to foreign exchange rates, interest rate changes, and certain credit spreads. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in gain (loss) on derivative financial instruments in our condensed consolidated statements of operations. The LNR conduit platform uses interest rate and credit index instruments to manage exposures related to commercial mortgage loans held-for-sale.

 

We have entered into a series of forward contracts whereby we agreed to sell an amount of GBP or EUR for an agreed upon amount of USD at various dates through March 2016. These forward contracts were executed to economically fix the USD amounts of foreign denominated cash flows expected to be received by us related to foreign denominated loan investments.

 

As of March 31, 2014, we had 69 foreign exchange forward derivatives to sell GBP with a total notional amount of  £228.8 million and 25 foreign exchange forward derivatives to sell EUR with a total notional amount of €138.9 million that were not designated as hedges in qualifying hedging relationships. Also as of March 31, 2014, there were 23 interest rate swaps where the Company is paying fixed rates, with maturities ranging from 2 to 10 years and a total notional amount of $97.6 million, four interest rate swaps where the Company is receiving fixed rates with maturities ranging from 1 to 4 years and a total notional of $64.2 million and eight credit index instruments with a total notional amount of $50.0 million.  The table below presents the fair value of our derivative financial instruments as well as their classification on the condensed consolidated balance sheets as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Fair Value of Derivatives in an
Asset Position(1) As of

 

Fair Value of Derivatives in a
Liability Position(2) As of

 

 

 

March 31, 2014

 

December 31, 2013

 

March 31, 2014

 

December 31, 2013

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

112

 

$

125

 

$

594

 

$

729

 

Total derivatives designated as hedging instruments

 

112

 

125

 

594

 

729

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

2,361

 

5,102

 

989

 

983

 

Foreign exchange contracts

 

266

 

269

 

16,474

 

22,480

 

Credit index instruments

 

1,878

 

2,273

 

 

 

Total derivatives not designated as hedging instruments

 

4,505

 

7,644

 

17,463

 

23,463

 

Total derivatives

 

$

4,617

 

$

7,769

 

$

18,057

 

$

24,192

 

 

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(1)                                 Classified as derivative assets in our condensed consolidated balance sheets.

 

(2)                                 Classified as derivative liabilities in our condensed consolidated balance sheets.

 

The tables below present the effect of our derivative financial instruments on the condensed consolidated statements of operations and of comprehensive income for the three months ended March 31, 2014 and 2013:

 

Derivatives Designated as
Hedging Instruments
for the Three Months Ended March 31,

 

Gain (Loss)
Recognized
in OCI
(effective portion)

 

Gain (Loss)
Reclassified
from AOCI
into Income
(effective portion)

 

Gain (Loss)
Recognized
in Income
(ineffective portion)

 

Location of Gain (Loss)
Recognized in Income

 

2014

 

$

(251

)

$

(373

)

$

 

Interest expense

 

2013

 

$

(167

)

$

(447

)

$

 

Interest expense

 

 

Derivatives Not Designated

 

 

 

Amount of Gain (Loss)
Recognized in Income for the

Three Months Ended March 31,

 

as Hedging Instruments

 

Location of Gain (Loss) Recognized in Income

 

2014

 

2013

 

Interest rate swaps

 

Loss (gain) on derivative financial instruments

 

$

(4,197

)

$

150

 

Foreign exchange contracts

 

Loss (gain) on derivative financial instruments

 

(3,047

)

16,078

 

Credit index instruments

 

Loss on derivative financial instruments

 

(622

)

 

 

 

 

 

$

(7,866

)

$

16,228

 

 

Credit-risk-related Contingent Features

 

We have entered into agreements with certain of our derivative counterparties that contain provisions providing that if we were to default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, we may also be declared in default on our derivative obligations. We also have certain agreements that contain provisions providing that if our ratio of principal amount of indebtedness to total assets at any time exceeds 75%, then we could be declared in default of our derivative obligations.

 

As of March 31, 2014, we had posted collateral of $17.1 million related to our derivative financial instruments.

 

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12. Offsetting Assets and Liabilities

 

The following tables present the potential effects of netting arrangements on our financial position for financial assets and liabilities within the scope of ASC 210-20, Balance Sheet—Offsetting, which for us are derivative assets and liabilities as well as repurchase agreement liabilities (amounts in thousands):

 

 

 

 

 

(ii)

 

(iii) = (i) - (ii)

 

(iv)
Gross Amounts Not
Offset in the Statement
of Financial Position

 

 

 

 

 

(i)
Gross Amounts
Recognized

 

Gross Amounts
Offset in the
Statement of
Financial Position

 

Net Amounts
Presented in
the Statement of
Financial Position

 

Financial
Instruments

 

Cash
Collateral
Received /
Pledged

 

(v) = (iii) - (iv)
Net Amount

 

As of March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

$

4,617

 

$

 

$

4,617

 

$

493

 

$

1,731

 

$

2,393

 

Derivative liabilities

 

$

18,057

 

$

 

$

18,057

 

$

493

 

$

12,065

 

$

5,499

 

Repurchase agreements

 

1,825,589

 

 

1,825,589

 

1,825,589

 

 

 

 

 

$

1,843,646

 

$

 

$

1,843,646

 

$

1,826,082

 

$

12,065

 

$

5,499

 

As of December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative assets

 

$

7,769

 

$

 

$

7,769

 

$

692

 

$

1,916

 

$

5,161

 

Derivative liabilities

 

$

24,192

 

$

 

$

24,192

 

$

692

 

$

7,150

 

$

16,350

 

Repurchase agreements

 

1,419,163

 

 

1,419,163

 

1,419,163

 

 

 

 

 

$

1,443,355

 

$

 

$

1,443,355

 

$

1,419,855

 

$

7,150

 

$

16,350

 

 

13. Variable Interest Entities

 

Investment Securities

 

As discussed in Note 2, we evaluate all of our investments and other interests in entities for consolidation, including our investments in CMBS and our retained interests in securitization transactions we initiated, all of which are generally considered to be variable interests in VIEs.

 

The VIEs consolidated in accordance with ASC 810 are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders. The assets and other instruments held by these securitization entities are restricted and can only be used to fulfill the obligations of the entity. Additionally, the obligations of the securitization entities do not have any recourse to the general credit of any other consolidated entities, nor to us as the primary beneficiary. The SPE liabilities initially represent investment securities on our balance sheet (pre-consolidation). Upon consolidation of these VIEs, our associated investment securities are eliminated, as is the interest income related to those securities. Similarly, the fees we earn in our roles as special servicer of the bonds issued by the consolidated VIEs or as collateral administrator of the consolidated VIEs are also eliminated. Finally, an allocable portion of the identified servicing intangible associated with the eliminated fee streams is eliminated in consolidation.

 

VIEs in which we are the Primary Beneficiary

 

The inclusion of the assets and liabilities of VIEs in which we are deemed the primary beneficiary has no economic effect on us. Our exposure to the obligations of VIEs is generally limited to our investment in these entities. We are not obligated to provide, nor have we provided, any financial support for any of these consolidated structures.

 

VIEs in which we are not the Primary Beneficiary

 

In certain instances, we hold a variable interest in a VIE in the form of CMBS, but either (i) we are not appointed, or do not serve as, special servicer or (ii) an unrelated third party has the rights to unilaterally remove us as special servicer. In these instances, we do not have the power to direct activities that most significantly impact the VIE’s economic performance. In other cases, the variable interest we hold does not obligate us to absorb losses or provide us with the right to receive benefits from the VIE which could potentially be significant. For these structures, we are not deemed to be the primary beneficiary of the VIE, and we do not consolidate these VIEs.

 

As of March 31, 2014, one of our collateralized debt obligation (“CDO”) structures was in default, which pursuant to the underlying indentures, changes the rights of the variable interest holders. Upon default of a CDO, the trustee or senior note holders are allowed to exercise certain rights, including liquidation of the collateral, which at that time, is the activity which would most

 

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significantly impact the CDO’s economic performance. Further, when the CDO is in default, the collateral administrator no longer has the option to purchase securities from the CDO. In cases where the CDO is in default and we do not have the ability to exercise rights which would most significantly impact the CDO’s economic performance, we do not consolidate the VIE. As of March 31, 2014, this CDO structure was not consolidated.  During the three months ended March 31, 2014, one of our CDOs, which was previously in default as of December 31, 2013, ceased to be in default.  As such, we consolidated the CDO and its underlying assets during the three months ended March 31, 2014.

 

As noted above, we are not obligated to provide, nor have we provided, any financial support for any of our securitization SPEs, whether or not we are deemed to be the primary beneficiary. As such, the risk associated with our involvement in these VIEs is limited to the carrying value of our investment in the entity. As of March 31, 2014, our maximum risk of loss related to VIEs in which we were not the primary beneficiary was $134.1 million on a fair value basis.

 

As of March 31, 2014, the securitization SPEs which we do not consolidate had debt obligations to beneficial interest holders with unpaid principal balances of $108.4 billion. The corresponding assets are comprised primarily of commercial mortgage loans with unpaid principal balances corresponding to the amounts of the outstanding debt obligations.

 

14. Related-Party Transactions

 

Management Agreement

 

We are subject to a management agreement (the “Management Agreement”) with our Manager, which provides for an initial term of three years with automatic one-year extensions thereafter unless terminated as described below. Under the Management Agreement, our Manager, subject to the oversight of our board of directors, is required to manage our day-to-day activities, for which our Manager receives a base management fee and is eligible for an incentive fee and stock awards. Our Manager’s personnel perform certain due diligence, legal, management and other services that outside professionals or consultants would otherwise perform. As such, in accordance with the terms of our Management Agreement, our Manager is paid or reimbursed for the documented costs of performing such tasks, provided that such costs and reimbursements are in amounts no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis. Refer to Note 16 to the consolidated financial statements included in our Form 10-K for further discussion of this agreement.

 

Base Management Fee.  For the three months ended March 31, 2014 and 2013, approximately $13.2 million and $9.7 million, respectively, was incurred for base management fees. As of March 31, 2014 and December 31, 2013, there were $13.2 million and $0 of unpaid base management fees, respectively, in our condensed consolidated balance sheets.

 

Incentive Fee.  For the three months ended March 31, 2014 and 2013, approximately $7.2 million and $0, respectively, was incurred for the incentive fee. As of March 31, 2014 and December 31, 2013, approximately $7.2 million and $6.8 million, respectively, of unpaid incentive fees were included in related-party payable in our condensed consolidated balance sheets.

 

Expense Reimbursement.  For the three months ended March 31, 2014 and 2013, approximately $1.9 million and $2.5 million was incurred, respectively, for executive compensation and other reimbursable expenses. As of both March 31, 2014 and December 31, 2013, approximately $4.4 million of unpaid reimbursable executive compensation and other expenses were included in related-party payable in our condensed consolidated balance sheets.

 

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Manager Equity Plan

 

In January 2014, we granted 2,489,281 restricted stock units to our Manager under the Starwood Property Trust, Inc. Manager Equity Plan (“Manager Equity Plan”).  In connection with these grants and prior similar grants, we recognized share-based compensation expense of $6.7 million within management fees in our condensed consolidated statement of operations for the three months ended March 31, 2014.  Refer to Note 15 herein for further discussion of these grants.

 

Investment in Loan

 

On October 2012, we co-originated $475.0 million in financing for the acquisition and redevelopment of a 10-story retail building located at 701 Seventh Avenue in the Times Square area of Manhattan through a joint venture with Starwood Distressed Opportunity Fund IX (“Fund IX”), an affiliate of our Manager.  In January 2014, we refinanced the initial financing with an $815.0 million first mortgage and mezzanine financing to facilitate the further development of the property.  Fund IX did not participate in the refinancing. As such, the joint venture distributed $31.6 million to Fund IX for the liquidation of their interest in the joint venture.

 

LNR Related-Party Arrangement

 

In connection with the LNR acquisition, we were required to cash collateralize certain obligations of LNR, including letters of credit and performance obligations. Fund IX funded $6.2 million of this obligation, but the account is within our name and is thus reflected within our restricted cash balance. We have recognized a corresponding payable to Fund IX of $4.4 million and $6.2 million within related-party payable in our condensed consolidated balance sheets as of March 31, 2014 and December 31, 2013, respectively.

 

15. Stockholders’ Equity

 

On February 24, 2014, our board of directors declared a dividend of $0.48 per share for the first quarter of 2014, which was paid on April 15, 2014 to common stockholders of record as of March 31, 2014.

 

Subsequent to March 31, 2014, we issued additional common stock under our currently effective shelf registration.  Refer to Note 23 herein for further details.

 

Equity Incentive Plans

 

The Company currently maintains the Manager Equity Plan, the Starwood Property Trust, Inc. Equity Plan (the “Equity Plan”), and the Starwood Property Trust, Inc. Non-Executive Director Stock Plan (“Non-Executive Director Stock Plan”).  Refer to Note 17 to the consolidated financial statements included in our Form 10-K for further information regarding these plans.

 

On January 2, 2014, the Company granted 2,000,000 restricted stock units to our Manager under the Manager Equity Plan. These awards vest ratably on a quarterly basis over a three-year period beginning on March 31, 2014 and had a grant date fair value of $55.4 million. On January 31, 2014, in connection with the spin-off of the SFR segment, the Company granted our Manager 489,281 restricted stock units of the Company in consideration of the Company’s currently unvested restricted stock units. Of these restricted stock units, 99,480 vest ratably on a quarterly basis over a 21-month period beginning on March 31, 2014 and 389,801 vest ratably on a quarterly basis over a three-year period beginning on March 31, 2014.  These restricted stock units had a grant date fair value of $14.8 million.

 

As of March 31, 2014, there were 3.4 million shares available for future grants under the Manager Equity Plan and the Equity Plan.

 

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Table of Contents

 

Schedule of Non-Vested Shares and Share Equivalents

 

 

 

Non-Executive
Director
Stock Plan

 

Equity Plan

 

Manager
Equity Plan

 

Total

 

Weighted
Average
Grant Date
Fair Value
(per share)

 

Balance as of December 31, 2013

 

11,228

 

22,502

 

510,415

 

544,145

 

$

22.88

 

Granted

 

 

147,911

 

2,489,281

 

2,637,192

 

27.96

 

Vested

 

 

(14,981

)

(286,278

)

(301,259

)

26.71

 

Forfeited

 

 

 

 

 

 

Balance as of March 31, 2014

 

11,228

 

155,432

 

2,713,418

 

2,880,078

 

$

27.13

 

 

16. Earnings per Share

 

We present both basic and diluted EPS amounts in our financial statements.  Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the maximum potential dilution that could occur from (i) our share-based compensation, consisting of unvested restricted stock units and awards, (ii) contingently issuable shares to our Manager; and (iii) the “in-the-money” conversion options associated with our outstanding Convertible Notes (see further discussion below). Potential dilutive shares are excluded from the calculation if they have an anti-dilutive effect in the period.

 

The Company’s unvested restricted share units and awards contain rights to receive non-forfeitable dividends and thus are participating securities.  Due to the existence of these participating securities, the two-class method of computing EPS is required, unless another method is determined to be more dilutive. Under the two-class method, undistributed earnings are reallocated between common shares and participating securities.  For the three months ended March 31, 2014 and 2013, the two-class method resulted in the most dilutive EPS calculation.

 

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The following table provides a reconciliation of net income from continuing operations and the number of common shares used in the computations of basic EPS and diluted EPS (in thousands, except per share amounts):

 

 

 

For the Three Month Ended
March 31,

 

 

 

2014

 

2013

 

Basic Earnings

 

 

 

 

 

Continuing Operations:

 

 

 

 

 

Income from continuing operations attributable to STWD common shareholders

 

$

122,152

 

$

64,531

 

Less: Income attributable to unvested shares

 

(1,748

)

(454

)

Basic — Income from continuing operations

 

$

120,404

 

$

64,077

 

 

 

 

 

 

 

Discontinued Operations:

 

 

 

 

 

Loss from discontinued operations

 

$

(1,551

)

$

(2,288

)

Basic — Net income attributable to STWD common shareholders after allocation to participating securities

 

$

118,853

 

$

61,789

 

 

 

 

 

 

 

Diluted Earnings

 

 

 

 

 

Continuing Operations:

 

 

 

 

 

Basic — Income from continuing operations attributable to STWD common shareholders

 

$

122,152

 

$

64,531

 

Less: Income attributable to unvested shares

 

(1,748

)

(454

)

Add: Undistributed earnings to unvested shares

 

366

 

18

 

Less: Undistributed earnings reallocated to unvested shares

 

(361

)

(18

)

Diluted — Income from continuing operations

 

$

120,409

 

$

64,077

 

 

 

 

 

 

 

Discontinued Operations:

 

 

 

 

 

Basic — Loss from discontinued operations

 

$

(1,551

)

$

(2,288

)

Diluted — Net income attributable to STWD common shareholders after allocation to participating securities

 

$

118,858

 

$

61,789

 

 

 

 

 

 

 

Number of Shares:

 

 

 

 

 

Basic — Average shares outstanding

 

195,524

 

135,480

 

Effect of dilutive securities — Convertible Notes

 

3,196

 

 

Effect of dilutive securities — Contingently Issuable Shares

 

156

 

 

Diluted — Average shares outstanding

 

198,876

 

135,480

 

 

 

 

 

 

 

Basic Earnings Per Share:

 

 

 

 

 

Income from continuing operations attributable to STWD common shareholders

 

$

0.62

 

$

0.47

 

Loss from discontinued operations attributable to STWD common shareholders

 

(0.01

)

(0.01

)

Net income attributable to STWD common shareholders

 

$

0.61

 

$

0.46

 

 

 

 

 

 

 

Diluted Earnings Per Share:

 

 

 

 

 

Income from continuing operations attributable to STWD common shareholders

 

$

0.61

 

$

0.47

 

Loss from discontinued operations attributable to STWD common shareholders

 

(0.01

)

(0.01

)

Net income attributable to STWD common shareholders

 

$

0.60

 

$

0.46

 

 

As of March 31, 2014 and 2013, unvested restricted shares of 2.9 million and 1.0 million, respectively, were excluded from the computation of diluted EPS as their effect was determined to be anti-dilutive.

 

Also as of March 31, 2014, there were 48.4 million potential shares of common stock contingently issuable upon the conversion of the Convertible Notes.  The Company has asserted its intent and ability to settle the principal amount of the Convertible Notes in cash.  As a result, this principal amount, representing 45.2 million shares at March 31, 2014, was not included in the computation of diluted EPS.  However, as discussed in Note 9, the conversion options associated with both Convertible Notes are “in-the-money.”  The if-converted value of the 2018 Notes and the 2019 Notes exceeded their respective principal amounts by $28.6 million and $53.6 million, respectively, at March 31, 2014.  The dilutive effect to EPS is determined by dividing this “conversion

 

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spread value” by the average share price. The “conversion spread value” is the value that would be delivered to investors in shares based on the terms of the Convertible Notes, upon an assumed conversion. In calculating the dilutive effect of these shares, the treasury stock method was used and resulted in a dilution of 3.2 million shares.

 

17. Accumulated Other Comprehensive Income

 

The changes in AOCI by component are as follows (in thousands):

 

 

 

Effective Portion of
Cumulative Loss on
Cash Flow Hedges

 

Cumulative
Unrealized Gain
(Loss) on
Available-for-
Sale Securities

 

Foreign
Currency
Translation

 

Total

 

Balance at January 1, 2014

 

$

(604

)

$

66,566

 

$

9,487

 

$

75,449

 

OCI before reclassifications

 

(251

)

3,983

 

1,046

 

4,778

 

Amounts reclassified from AOCI

 

373

 

(485

)

 

(112

)

Net period OCI

 

122

 

3,498

 

1,046

 

4,666

 

Balance at March 31, 2014

 

$

(482

)

$

70,064

 

$

10,533

 

$

80,115

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2013

 

$

(2,571

)

$

82,246

 

$

 

$

79,675

 

OCI before reclassifications

 

(168

)

11,956

 

(7,061

)

4,727

 

Amounts reclassified from AOCI

 

447

 

(14,305

)

 

(13,858

)

Net period OCI

 

279

 

(2,349

)

(7,061

)

(9,131

)

Balance at March 31, 2013

 

$

(2,292

)

$

79,897

 

$

(7,061

)

$

70,544

 

 

The reclassifications out of AOCI impacted the condensed consolidated statements of operations for the three months ended March 31, 2014 and 2013 as follows:

 

 

 

Amounts Reclassified from
AOCI during the Three Months
Ended March 31,

 

Affected Line Item
in the Statements

 

Details about AOCI Components

 

2014

 

2013

 

of Operations

 

Gains (losses) on cash flow hedges:

 

 

 

 

 

 

 

Interest rate contracts

 

$

(373

)

$

(447

)

Interest expense

 

Unrealized gains (losses) on available for sale securities:

 

 

 

 

 

 

 

Net realized gain (loss) on sale of investments

 

698

 

14,347

 

Gain on sale of investments, net

 

OTTI

 

(213

)

(42

)

OTTI

 

Total

 

485

 

14,305

 

 

 

Total reclassifications for the year

 

$

112

 

$

13,858

 

 

 

 

18. Benefit Plans

 

Change in Control Retention Arrangements

 

In connection with the LNR acquisition, we assumed certain performance obligations under the LNR Property LLC Change in Control Bonus Plan (the “Change in Control Plan”) as discussed further in Note 20 to the consolidated financial statements included in our Form 10-K.  The balance of the Change in Control Plan, which was pre-funded by the sellers of LNR into a Rabbi Trust, was paid to participants during the three months ended March 31, 2014.

 

19. Fair Value

 

GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

 

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Table of Contents

 

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

 

Valuation Process

 

We have valuation control processes in place to validate the fair value of the Company’s financial assets and liabilities measured at fair value including those derived from pricing models. These control processes are designed to assure that the values used for financial reporting are based on observable inputs wherever possible.  Refer to Note 21 to the consolidated financial statements included in our Form 10-K for further discussion of our valuation process.

 

We determine the fair value of our assets and liabilities measured at fair value on a recurring and nonrecurring basis in accordance with the methodology described in our Form 10-K.

 

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Table of Contents

 

The following tables present our financial assets and liabilities carried at fair value on a recurring basis in the condensed consolidated balance sheets by their level in the fair value hierarchy as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

March 31, 2014

 

 

 

Total

 

Level I

 

Level II

 

Level III

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Loans held-for-sale, fair value option

 

$

186,837

 

$

 

$

112,720

 

$

74,117

 

RMBS

 

291,217

 

 

 

291,217

 

CMBS

 

247,601

 

 

6,936

 

240,665

 

Equity security

 

15,115

 

15,115

 

 

 

Domestic servicing rights

 

144,898

 

 

 

144,898

 

Derivative assets

 

4,617

 

 

4,617

 

 

VIE assets

 

118,451,518

 

 

 

118,451,518

 

Total

 

$

119,341,803

 

$

15,115

 

$

124,273

 

$

119,202,415

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

$

18,057

 

$

 

$

18,057

 

$

 

VIE liabilities

 

117,931,005

 

 

114,448,083

 

3,482,922

 

Total

 

$

117,949,062

 

$

 

$

114,466,140

 

$

3,482,922

 

 

 

 

December 31, 2013

 

 

 

Total

 

Level I

 

Level II

 

Level III

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Loans held-for-sale, fair value option

 

$

206,672

 

$

 

$

 

$

206,672

 

RMBS

 

296,236

 

 

 

296,236

 

CMBS

 

255,306

 

 

47,300

 

208,006

 

Equity security

 

15,247

 

15,247

 

 

 

Domestic servicing rights

 

150,149

 

 

 

150,149

 

Derivative assets

 

7,769

 

 

7,769

 

 

VIE assets

 

103,151,624

 

 

 

103,151,624

 

Total

 

$

104,083,003

 

$

15,247

 

$

55,069

 

$

104,012,687

 

Financial Liabilities:

 

 

 

 

 

 

 

 

 

Derivative liabilities

 

$

24,192

 

$

 

$

24,192

 

$

 

VIE liabilities

 

102,649,263

 

 

101,051,279

 

1,597,984

 

Total

 

$

102,673,455

 

$

 

$

101,075,471

 

$

1,597,984

 

 

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Table of Contents

 

The changes in financial assets and liabilities classified as Level III were as follows for the three months ended March 31, 2014 and 2013 (amounts in thousands):

 

 

 

Loans
Held-for-sale

 

RMBS

 

CMBS

 

Domestic
Servicing
Rights

 

VIE Assets

 

VIE
Liabilities

 

Total

 

January 1, 2014 balance

 

$

206,672

 

$

296,236

 

$

208,006

 

$

150,149

 

$

103,151,624

 

$

(1,597,984

)

$

102,414,703

 

Total realized and unrealized (losses) gains:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in fair value / gain on sale

 

20,893

 

1,011

 

5,207

 

(5,251

)

(3,681,541

)

101,499

 

(3,558,182

)

OTTI

 

 

(213

)

 

 

 

 

(213

)

Net accretion

 

 

6,564

 

 

 

 

 

6,564

 

Included in OCI

 

 

4,748

 

(533

)

 

 

 

4,215

 

Purchases / Originations

 

261,825

 

 

3,831

 

 

 

 

265,656

 

Sales

 

(302,461

)

(9,310

)

(15,844

)

 

 

 

(327,615

)

Issuances

 

 

 

 

 

 

(45,761

)

(45,761

)

Cash repayments / receipts

 

(92

)

(7,819

)

(408

)

 

 

35,366

 

27,047

 

Transfers into Level III

 

 

 

47,300

 

 

 

(571,612

)

(524,312

)

Transfers out of Level III

 

(112,720

)

 

(179

)

 

 

419,741

 

306,842

 

Consolidations of VIEs

 

 

 

(6,715

)

 

20,270,649

 

(1,824,171

)

18,439,763

 

Deconsolidations of VIEs

 

 

 

 

 

(1,289,214

)

 

(1,289,214

)

March 31, 2014 balance

 

$

74,117

 

$

291,217

 

$

240,665

 

$

144,898

 

$

118,451,518

 

$

(3,482,922

)

$

115,719,493

 

Amount of total (losses) gains included in earnings attributable to assets still held at March 31, 2014

 

$

177

 

$

6,295

 

$

5,207

 

$

(5,251

)

$

(3,681,541

)

$

101,499

 

$

(3,573,614

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

January 1, 2013 balance

 

$

 

$

333,153

 

$

 

$

 

$

 

$

 

$

333,153

 

Total realized and unrealized gains:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Included in earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

OTTI

 

 

(42

)

 

 

 

 

(42

)

Net accretion

 

 

6,151

 

 

 

 

 

6,151

 

Included in OCI

 

 

9,232

 

 

 

 

 

9,232

 

Sales

 

 

(10,582

)

 

 

 

 

(10,582

)

Cash repayments / receipts

 

 

 

(16,869

)

 

 

 

 

 

 

 

 

(16,869

)

March 31, 2013 balance

 

$

 

$

321,043

 

$

 

$

 

$

 

$

 

$

321,043

 

Amount of total gains included in earnings attributable to assets still held at March 31, 2013

 

$

 

$

6,109

 

$

 

$

 

$

 

$

 

$

6,109

 

 

During the three months ended March 31, 2014, we transferred $47.3 million of CMBS investments from Level II to Level III due to a decrease in the observable relevant market activity.

 

The following table presents the fair values of our financial instruments not carried at fair value on the consolidated balance sheets (amounts in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

Carrying
Value

 

Fair
Value

 

Carrying
Value

 

Fair
Value

 

Financial assets not carried at fair value:

 

 

 

 

 

 

 

 

 

Loans held-for-investment and loans transferred as secured borrowings

 

$

4,777,965

 

$

4,885,290

 

$

4,544,132

 

$

4,609,040

 

Securities, held-to-maturity

 

369,152

 

367,811

 

368,318

 

368,453

 

European servicing rights

 

23,158

 

24,357

 

27,024

 

29,327

 

Non-performing residential loans

 

 

 

215,371

 

215,371

 

Financial liabilities not carried at fair value:

 

 

 

 

 

 

 

 

 

Secured financing agreements and secured borrowings on transferred loans

 

$

2,744,100

 

$

2,743,969

 

$

2,438,798

 

$

2,436,708

 

Convertible senior notes

 

1,000,839

 

1,216,482

 

997,851

 

1,160,000

 

 

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Table of Contents

 

The following is quantitative information about significant unobservable inputs in our Level III measurements for those assets and liabilities measured at fair value on a recurring basis (dollar amounts in thousands):

 

 

 

Carrying Value at

 

Valuation

 

 

 

Range as of (1)

 

 

 

March 31, 2014

 

Technique

 

Unobservable Input

 

March 31, 2014

 

December 31, 2013

 

Loans held-for-sale, fair value option

 

$

74,117

 

Discounted cash flow

 

Yield (b)

 

4.8% - 6.6%

 

5.2% - 5.9%

 

 

 

 

 

 

 

Duration(c)

 

5.0 - 10.0 years

 

5.0 - 10.0 years

 

RMBS

 

291,217

 

Discounted cash flow

 

Constant prepayment rate(a)

 

0.9% - 16.4%

 

(0.6)% - 16.6%

 

 

 

 

 

 

 

Constant default rate(b)

 

1.4% - 9.5%

 

1.4% - 11.3%

 

 

 

 

 

 

 

Loss severity(b)

 

13% - 82%(e)

 

15% - 92%(e)

 

 

 

 

 

 

 

Delinquency rate(c)

 

3% - 32%

 

3% - 48%

 

 

 

 

 

 

 

Servicer advances(a)

 

23% - 96%

 

24% - 95%

 

 

 

 

 

 

 

Annual coupon deterioration(b)

 

0% - 0.9%

 

0% - 0.7%

 

 

 

 

 

 

 

Putback amount per projected

 

 

 

 

 

 

 

 

 

 

 

total collateral loss(d)

 

0% - 10%

 

0% - 9%

 

CMBS

 

240,665

 

Discounted cash flow

 

Yield(b)

 

0% - 457.8%

 

0% - 890.0%

 

 

 

 

 

 

 

Duration(c)

 

0 – 11.9 years

 

0 - 11.0 years

 

Domestic servicing rights

 

144,898

 

Discounted cash flow

 

Debt yield(a)

 

8.75%

 

8.75%

 

 

 

 

 

 

 

Discount rate(b)

 

15%

 

15%

 

 

 

 

 

 

 

Control migration(b)

 

0% - 80%

 

0% - 80%

 

VIE assets

 

118,451,518

 

Discounted cash flow

 

Yield(b)

 

0% - 968.9%

 

0% - 952.3%

 

 

 

 

 

 

 

Duration(c)

 

0 – 22.4 years

 

0 - 22.7 years

 

VIE liabilities

 

3,482,922

 

Discounted cash flow

 

Yield(b)

 

0% - 968.9%

 

0% - 952.3%

 

 

 

 

 

 

 

Duration(c)

 

0 – 22.4 years

 

0 - 22.7 years

 

 


(1)                                 The ranges of significant unobservable inputs are represented in percentages and years.

 

Sensitivity of the Fair Value to Changes in the Unobservable Inputs

 

(a)                                 Significant increase (decrease) in the unobservable input in isolation would result in a significantly higher (lower) fair value measurement.

 

(b)                                 Significant increase (decrease) in the unobservable input in isolation would result in a significantly lower (higher) fair value measurement.

 

(c)                                  Significant increase (decrease) in the unobservable input in isolation would result in either a significantly lower or higher (lower or higher) fair value measurement depending on the structural features of the security in question.

 

(d)                                 Any delay in the putback recovery date leads to a decrease in fair value, for the majority of securities in our RMBS portfolio.

 

(e)                                  88% and 90% of the portfolio falls within a range of 45%-80% as of March 31, 2014 and December 31, 2013, respectively.

 

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20.  Income Taxes

 

As described in Note 1, we established additional TRSs to hold certain operations of the LNR Segment. Our income tax provision consisted of the following for the three months ended March 31, 2014 and 2013 (in thousands):

 

 

 

For the Three Months Ended
March 31,

 

 

 

2014

 

2013

 

Current

 

 

 

 

 

Federal

 

$

5,140

 

$

631

 

Foreign

 

1,449

 

 

State

 

870

 

146

 

Total current

 

7,459

 

777

 

Deferred

 

 

 

 

 

Federal

 

(704

)

 

Foreign

 

(1,006

)

 

State

 

(129

)

 

Total deferred

 

(1,839

)

 

Total income tax provision (1)

 

$

5,620

 

$

777

 

 


(1)                     Includes $0 and $162 thousand reflected in discontinued operations for the three months ended March 31, 2014 and 2013, respectively.

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred tax assets and liabilities are presented net by tax jurisdiction and are reported in other assets and other liabilities, respectively. At March 31, 2014 and December 31, 2013, our U.S. tax jurisdiction was in a net deferred tax asset position, while our European tax jurisdiction was in a net deferred tax liability position. The following table presents each of these tax jurisdictions and the tax effects of temporary differences on their respective net deferred tax assets and liabilities (in thousands):

 

 

 

March 31, 2014

 

December 31, 2013

 

U.S.

 

 

 

 

 

Deferred tax asset, net

 

 

 

 

 

Reserves and accruals

 

$

10,872

 

$

11,454

 

Domestic intangible assets

 

1,198

 

(714

)

Investment securities and loans

 

(1,910

)

(892

)

Investment in unconsolidated entities

 

2,082

 

1,811

 

Deferred income

 

194

 

59

 

Net operating and capital loss carryforwards

 

2,479

 

967

 

Valuation allowance

 

(2,479

)

(799

)

Other U.S. temporary differences

 

(229

)

(242

)

 

 

12,207

 

11,644

 

Europe

 

 

 

 

 

Deferred tax liability, net

 

 

 

 

 

European servicing rights

 

(5,295

)

(6,257

)

Net operating and capital loss carryforwards

 

10,996

 

10,951

 

Valuation allowance

 

(10,996

)

(10,951

)

Other European temporary differences

 

(373

)

(527

)

 

 

(5,668

)

(6,784

)

Net deferred tax assets (liabilities)

 

$

6,539

 

$

4,860

 

 

Unrecognized tax benefits were not material as of and during the three months ended March 31, 2014.

 

39



Table of Contents

 

The following table is a reconciliation of our federal income tax determined using our statutory federal tax rate to our reported income tax provision for the three months ended March 31, 2014 and 2013 (dollar amounts in thousands):

 

 

 

For the Three Months Ended March 31,

 

 

 

2014

 

2013

 

Federal statutory tax rate

 

$

44,275

 

35.0

%

$

22,470

 

35.0

%

REIT and other non-taxable income

 

(40,382

)

(32.0

)%

(21,788

)

(33.9

)%

State income taxes

 

450

 

0.4

%

146

 

0.2

%

Federal benefit of state tax deduction

 

(158

)

(0.1

)%

(51

)

(0.1

)%

Valuation allowance

 

1,512

 

1.2

%

 

 

Other

 

(77

)

(0.1

)%

 

 

Effective tax rate

 

$

5,620

 

4.4

%

$

777

 

1.2

%

 

21. Commitments and Contingencies

 

As of March 31, 2014, we had future funding commitments on 43 loans totaling $1.8 billion, primarily related to construction projects, capital improvements, tenant improvements, and leasing commissions. Generally, funding commitments are subject to certain conditions that must be met, such as customary construction draw certifications, minimum debt service coverage ratios or executions of new leases before advances are made to the borrower.

 

Management is not aware of any other contractual obligations, legal proceedings, or any other contingent obligations incurred in the normal course of business that would have a material adverse effect on our condensed consolidated financial statements.

 

40



Table of Contents

 

22.  Segment Data

 

In its operation of the business, management, including our chief operating decision maker, who is our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis prior to the impact of consolidating VIEs under ASC 810. The segment information within this note is reported on that basis.  Refer to Note 24 to the consolidated financial statements included in our Form 10-K for further discussion of the composition of our reportable business segments.

 

The table below presents our results of operations for the three months ended March 31, 2014 by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

LNR

 

Single Family
Residential

 

Subtotal

 

LNR VIEs

 

Total

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income from loans

 

$

102,087

 

$

2,823

 

$

 

$

104,910

 

$

 

$

104,910

 

Interest income from investment securities

 

18,289

 

23,008

 

 

41,297

 

(11,843

)

29,454

 

Servicing fees

 

37

 

56,185

 

 

56,222

 

(22,011

)

34,211

 

Other revenues

 

80

 

3,597

 

 

3,677

 

(273

)

3,404

 

Total revenues

 

120,493

 

85,613

 

 

206,106

 

(34,127

)

171,979

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Management fees (1)

 

27,765

 

18

 

 

27,783

 

38

 

27,821

 

Interest expense (1)

 

36,880

 

951

 

 

37,831

 

 

37,831

 

General and administrative

 

7,145

 

38,770

 

 

45,915

 

186

 

46,101

 

Acquisition and investment pursuit costs

 

212

 

182

 

 

394

 

 

394

 

Depreciation and amortization

 

 

4,636

 

 

4,636

 

 

4,636

 

Loan loss allowance

 

497

 

 

 

497

 

 

497

 

Other expense

 

(14

)

1,703

 

 

1,689

 

 

1,689

 

Segment allocations (1)

 

(12,036

)

10,154

 

1,882

 

 

 

 

Total costs and expenses

 

60,449

 

56,414

 

1,882

 

118,745

 

224

 

118,969

 

Income before other income, income taxes and non-controlling interests

 

60,044

 

29,199

 

(1,882

)

87,361

 

(34,351

)

53,010

 

Other income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income of consolidated VIEs, net

 

 

 

 

 

56,004

 

56,004

 

Change in fair value of servicing rights

 

 

(12,175

)

 

(12,175

)

6,924

 

(5,251

)

Change in fair value of investment securities, net

 

(156

)

36,952

 

 

36,796

 

(28,435

)

8,361

 

Change in fair value of mortgage loans held-for-sale, net

 

 

20,893

 

 

20,893

 

 

20,893

 

Earnings from unconsolidated entities

 

1,540

 

(1,383

)

 

157

 

(93

)

64

 

Gain on sale of investments, net

 

1,555

 

 

 

1,555

 

 

1,555

 

Loss on derivative financial instruments, net

 

(2,788

)

(5,078

)

 

(7,866

)

 

(7,866

)

Foreign currency gain (loss), net

 

1,561

 

(84

)

 

1,477

 

 

1,477

 

OTTI

 

(213

)

 

 

(213

)

 

(213

)

Other income, net

 

18

 

 

 

18

 

 

18

 

Total other income

 

1,517

 

39,125

 

 

40,642

 

34,400

 

75,042

 

Income from continuing operations before income taxes

 

61,561

 

68,324

 

(1,882

)

128,003

 

49

 

128,052

 

Income tax provision

 

(83

)

(5,537

)

 

(5,620

)

 

(5,620

)

Income from continuing operations

 

61,478

 

62,787

 

(1,882

)

122,383

 

49

 

122,432

 

Loss from discontinued operations, net of tax

 

 

 

(1,551

)

(1,551

)

 

(1,551

)

Net income

 

61,478

 

62,787

 

(3,433

)

120,832

 

49

 

120,881

 

Net income attributable to non-controlling interests

 

(231

)

 

 

(231

)

(49

)

(280

)

Net income attributable to Starwood Property Trust, Inc.

 

$

61,247

 

$

62,787

 

$

(3,433

)

$

120,601

 

$

 

$

120,601

 

 


(1)                     Due to the structure of our business, certain costs incurred by one segment may benefit other segments. Costs that are identifiable are allocated to the segments that benefit so that one segment is not solely burdened by this cost. Allocated costs currently include interest expense related to our consolidated debt (excluding VIEs) and management fees payable to our Manager, both of which represent shared costs. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated.

 

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Table of Contents

 

The table below presents our results of operations for the three months ended March 31, 2013 by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

Single Family
Residential

 

Total

 

Revenues:

 

 

 

 

 

 

 

Interest income from loans

 

$

67,690

 

$

 

$

67,690

 

Interest income from investment securities

 

16,240

 

 

16,240

 

Other revenues

 

79

 

 

79

 

Total revenues

 

84,009

 

 

84,009

 

Costs and expenses:

 

 

 

 

 

 

 

Management fees

 

15,069

 

 

15,069

 

Interest expense

 

17,426

 

 

17,426

 

General and administrative

 

4,038

 

 

4,038

 

Business combination costs

 

4,196

 

 

4,196

 

Acquisition and investment pursuit costs

 

81

 

 

81

 

Loan loss allowance

 

30

 

 

30

 

Other expense

 

33

 

 

33

 

Total costs and expenses

 

40,873

 

 

40,873

 

Income before other income, income taxes and non-controlling interests

 

43,136

 

 

43,136

 

Other income:

 

 

 

 

 

 

 

Change in fair value of investment securities, net

 

405

 

 

405

 

Earnings from unconsolidated entities

 

741

 

 

741

 

Gain on sale of investments, net

 

13,524

 

 

13,524

 

Gain on derivative financial instruments, net

 

16,228

 

 

16,228

 

Foreign currency loss, net

 

(7,665

)

 

(7,665

)

OTTI

 

(42

)

 

(42

)

Total other income

 

23,191

 

 

23,191

 

Income from continuing operations before income taxes

 

66,327

 

 

66,327

 

Income tax provision

 

(615

)

 

(615

)

Income from continuing operations

 

65,712

 

 

65,712

 

Loss from discontinued operations, net of tax

 

 

(2,288

)

(2,288

)

Net income

 

65,712

 

(2,288

)

63,424

 

Net income attributable to non-controlling interests

 

(1,181

)

 

(1,181

)

Net income attributable to Starwood Property Trust, Inc.

 

$

64,531

 

$

(2,288

)

$

62,243

 

 

42



Table of Contents

 

The table below presents our condensed consolidated balance sheet as of March 31, 2014 by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

LNR

 

Subtotal

 

LNR VIEs

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

174,821

 

$

51,398

 

$

226,219

 

$

252

 

$

226,471

 

Restricted cash

 

34,000

 

9,117

 

43,117

 

 

43,117

 

Loans held-for-investment, net

 

4,625,020

 

9,903

 

4,634,923

 

 

4,634,923

 

Loans held-for-sale

 

 

186,837

 

186,837

 

 

186,837

 

Loans transferred as secured borrowings

 

143,042

 

 

143,042

 

 

143,042

 

Investment securities

 

788,961

 

564,818

 

1,353,779

 

(430,694

)

923,085

 

Intangible assets—servicing rights

 

 

245,032

 

245,032

 

(76,976

)

168,056

 

Investment in unconsolidated entities

 

46,395

 

61,601

 

107,996

 

(3,476

)

104,520

 

Goodwill

 

 

140,437

 

140,437

 

 

140,437

 

Derivative assets

 

2,666

 

1,951

 

4,617

 

 

4,617

 

Accrued interest receivable

 

33,955

 

560

 

34,515

 

 

34,515

 

Other assets

 

49,875

 

62,384

 

112,259

 

(1,036

)

111,223

 

VIE assets, at fair value

 

 

 

 

118,451,518

 

118,451,518

 

Total Assets

 

$

5,898,735

 

$

1,334,038

 

$

7,232,773

 

$

117,939,588

 

$

125,172,361

 

Liabilities and Equity

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

41,085

 

$

96,403

 

$

137,488

 

$

343

 

$

137,831

 

Related-party payable

 

25,016

 

4,442

 

29,458

 

 

29,458

 

Dividends payable

 

95,424

 

 

95,424

 

 

95,424

 

Derivative liabilities

 

17,917

 

140

 

18,057

 

 

18,057

 

Secured financing agreements, net

 

2,492,530

 

108,532

 

2,601,062

 

 

2,601,062

 

Convertible senior notes, net

 

1,000,839

 

 

1,000,839

 

 

1,000,839

 

Secured borrowings on transferred loans

 

143,038

 

 

143,038

 

 

143,038

 

VIE liabilities, at fair value

 

 

 

 

117,931,005

 

117,931,005

 

Total Liabilities

 

3,815,849

 

209,517

 

4,025,366

 

117,931,348

 

121,956,714

 

Equity:

 

 

 

 

 

 

 

 

 

 

 

Starwood Property Trust, Inc. Stockholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

 

Common stock

 

1,967

 

 

1,967

 

 

1,967

 

Additional paid-in capital

 

1,909,038

 

1,283,207

 

3,192,245

 

 

3,192,245

 

Treasury stock

 

(10,642

)

 

(10,642

)

 

(10,642

)

Accumulated other comprehensive income

 

72,428

 

7,687

 

80,115

 

 

80,115

 

Retained earnings (deficit)

 

106,831

 

(166,373

)

(59,542

)

 

(59,542

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

2,079,622

 

1,124,521

 

3,204,143

 

 

3,204,143

 

Non-controlling interests in consolidated subsidiaries

 

3,264

 

 

3,264

 

8,240

 

11,504

 

Total Equity

 

2,082,886

 

1,124,521

 

3,207,407

 

8,240

 

3,215,647

 

Total Liabilities and Equity

 

$

5,898,735

 

$

1,334,038

 

$

7,232,773

 

$

117,939,588

 

$

125,172,361

 

 

43



Table of Contents

 

The table below presents our condensed consolidated balance sheet as of December 31, 2013 by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

Single
Family
Residential

 

LNR

 

Subtotal

 

LNR VIEs

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

232,270

 

$

44,807

 

$

40,274

 

$

317,351

 

$

276

 

$

317,627

 

Restricted cash

 

36,593

 

251

 

32,208

 

69,052

 

 

69,052

 

Loans held-for-investment, net

 

4,350,937

 

 

12,781

 

4,363,718

 

 

4,363,718

 

Loans held-for-sale

 

 

 

206,672

 

206,672

 

 

206,672

 

Loans transferred as secured borrowings

 

180,414

 

 

 

180,414

 

 

180,414

 

Investment securities

 

794,147

 

 

550,282

 

1,344,429

 

(409,322

)

935,107

 

Intangible assets—servicing rights

 

 

 

257,736

 

257,736

 

(80,563

)

177,173

 

Residential real estate, net

 

 

749,214

 

 

749,214

 

 

749,214

 

Non-performing residential loans

 

 

215,371

 

 

215,371

 

 

215,371

 

Investment in unconsolidated entities

 

50,167

 

 

76,170

 

126,337

 

(3,383

)

122,954

 

Goodwill

 

 

 

140,437

 

140,437

 

 

140,437

 

Derivative assets

 

3,138

 

 

4,631

 

7,769

 

 

7,769

 

Accrued interest receivable

 

35,501

 

 

2,129

 

37,630

 

 

37,630

 

Other assets

 

31,020

 

8,045

 

57,620

 

96,685

 

(872

)

95,813

 

VIE assets, at fair value

 

 

 

 

 

103,151,624

 

103,151,624

 

Total Assets

 

$

5,714,187

 

$

1,017,688

 

$

1,380,940

 

$

8,112,815

 

$

102,657,760

 

$

110,770,575

 

Liabilities and Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable, accrued expenses and other liabilities

 

$

66,127

 

$

23,056

 

$

135,882

 

$

225,065

 

$

309

 

$

225,374

 

Related-party payable

 

11,245

 

 

6,548

 

17,793

 

 

17,793

 

Dividends payable

 

90,171

 

 

 

90,171

 

 

90,171

 

Derivative liabilities

 

24,149

 

 

43

 

24,192

 

 

24,192

 

Secured financing agreements, net

 

2,127,717

 

 

129,843

 

2,257,560

 

 

2,257,560

 

Convertible senior notes, net

 

997,851

 

 

 

997,851

 

 

997,851

 

Secured borrowings on transferred loans

 

181,238

 

 

 

181,238

 

 

181,238

 

VIE liabilities, at fair value

 

 

 

 

 

102,649,263

 

102,649,263

 

Total Liabilities

 

3,498,498

 

23,056

 

272,316

 

3,793,870

 

102,649,572

 

106,443,442

 

Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Starwood Property Trust, Inc. Stockholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

 

 

Common stock

 

1,961

 

 

 

1,961

 

 

1,961

 

Additional paid-in capital

 

1,987,133

 

1,004,846

 

1,308,500

 

4,300,479

 

 

4,300,479

 

Treasury stock

 

(10,642

)

 

 

(10,642

)

 

(10,642

)

Accumulated other comprehensive income

 

68,092

 

 

7,357

 

75,449

 

 

75,449

 

Retained earnings (deficit)

 

132,625

 

(10,111

)

(207,233

)

(84,719

)

 

(84,719

)

Total Starwood Property Trust, Inc. Stockholders’ Equity

 

2,179,169

 

994,735

 

1,108,624

 

4,282,528

 

 

4,282,528

 

Non-controlling interests in consolidated subsidiaries

 

36,520

 

(103

)

 

36,417

 

8,188

 

44,605

 

Total Equity

 

2,215,689

 

994,632

 

1,108,624

 

4,318,945

 

8,188

 

4,327,133

 

Total Liabilities and Equity

 

$

5,714,187

 

$

1,017,688

 

$

1,380,940

 

$

8,112,815

 

$

102,657,760

 

$

110,770,575

 

 

44



Table of Contents

 

23. Subsequent Events

 

Our significant events subsequent to March 31, 2014 were as follows:

 

Issuance of Common Shares

 

On April 11, 2014, we issued 22.0 million shares of common stock for gross proceeds of $491.0 million.  In connection with this offering, the underwriters had a 30-day option to purchase an additional 3.3 million shares of common stock, which they exercised in full, resulting in additional gross proceeds of $73.7 million.

 

Dividend Declaration

 

On May 6, 2014, our board of directors declared a dividend of $0.48 per share for the second quarter of 2014, which is payable on July 15, 2014 to common stockholders of record as of June 30, 2014.

 

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Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the information included elsewhere in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Form 10-K”). This discussion contains forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from the results discussed in the forward-looking statements.  See “Special Note Regarding Forward-Looking Statements” at the beginning of this Quarterly Report on Form 10-Q.

 

Overview

 

Starwood Property Trust, Inc. (“STWD” together with its subsidiaries, “we” or the “Company”) is a Maryland corporation that commenced operations in August 2009, upon the completion of our initial public offering (“IPO”). We are focused primarily on originating, acquiring, financing and managing commercial mortgage loans and other commercial real estate debt investments, commercial mortgage-backed securities (“CMBS”), and other commercial real estate-related debt investments in both the U.S. and Europe. We refer to the following as our target assets:

 

· commercial real estate mortgage loans, including preferred equity interests;

 

· CMBS; and

 

· other commercial real estate-related debt investments.

 

We may also invest in residential mortgage-backed securities (“RMBS”), certain residential mortgage loans, distressed or non-performing commercial loans, commercial properties subject to net leases and commercial real estate owned. As market conditions change over time, we may adjust our strategy to take advantage of changes in interest rates and credit spreads as well as economic and credit conditions.

 

We have three reportable business segments which include:

 

·                  Real estate investment lending (the “Lending Segment”)—includes all business activities of the Company, excluding the single family residential and LNR businesses, which generally represents investments in real estate related loans and securities that are held-for-investment.

 

·                  LNR—includes all business activities of the acquired LNR Property LLC (“LNR”) business excluding the consolidation of securitization VIEs.

 

·                  Single family residential (“SFR”)—includes the business activities associated with our investments in single-family residential properties and non-performing single-family residential mortgage loans.  This segment was spun off on January 31, 2014 as discussed below and in Note 3 to our condensed consolidated financial statements herein.

 

On April 19, 2013, we acquired the equity of LNR and certain of its subsidiaries for an initial agreed upon purchase price of approximately $859 million, which was reduced for transaction expenses and distributions occurring after September 30, 2012, resulting in cash consideration of approximately $730 million. Immediately prior to the acquisition, an affiliate of the Company acquired the remaining equity comprising LNR’s commercial property division for a purchase price of $194 million. The portion of the LNR business acquired by us includes the following: (i) servicing businesses in both the U.S. and Europe that manage and work out problem assets, (ii) a finance business that is focused on selectively acquiring and managing real estate finance investments, including unrated, investment grade and non-investment grade rated CMBS, including subordinated interests of securitization and resecuritization transactions, and high yielding real estate loans; and (iii) a mortgage loan business which originates conduit loans for the primary purpose of selling these loans into securitization transactions.

 

On January 31, 2014, we completed the spin-off of our SFR segment to our stockholders. The newly-formed real estate investment trust, Starwood Waypoint Residential Trust (“SWAY”), is listed on the New York Stock Exchange (“NYSE”) and trades under the ticker symbol “SWAY.” Our stockholders received one common share of SWAY for every five shares of our common stock held at the close of business on January 24, 2014. As part of the spin-off, we contributed $100 million to the unlevered balance sheet of SWAY to fund its growth and operations. As of January 31, 2014, SWAY held net assets of $1.1 billion. The net assets of SWAY consisted of approximately 7,200 units of single-family homes and residential non-performing mortgage loans as of January 31, 2014. In connection with the spin-off, 40.1 million shares of SWAY were issued. Refer to Note 3 herein for additional information regarding SFR segment financial information.

 

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We are organized and conduct our operations to qualify as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As such, we will generally not be subject to U.S. federal corporate income tax on that portion of our net income that is distributed to stockholders if we distribute at least 90% of our taxable income to our stockholders by prescribed dates and comply with various other requirements.

 

In connection with the LNR acquisition, we established additional taxable REIT subsidiaries (“TRSs”). TRSs permit us to participate in certain activities from which REITs are generally precluded, as long as these activities meet specific criteria, are conducted within the parameters of certain limitations established by the Code, and are conducted in entities which elect to be treated as taxable subsidiaries under the Code. To the extent these criteria are met, we will continue to maintain our qualification as a REIT.

 

These TRSs engage in various real estate related operations, including special servicing of commercial real estate, originating and securitizing commercial mortgage loans, and investing in entities which engage in real estate related operations. As of March 31, 2014, $799.8 million of the LNR assets were owned by TRS entities. Our TRSs are not consolidated for federal income tax purposes, but are instead taxed as corporations. For financial reporting purposes, a provision for current and deferred taxes is established for the portion of earnings recognized by us with respect to our interest in TRSs.

 

We are organized as a holding company and conduct our business primarily through our various wholly-owned subsidiaries. We are externally managed and advised by SPT Management, LLC (our “Manager”) pursuant to the terms of a management agreement. Our Manager is controlled by Barry Sternlicht, our Chairman and Chief Executive Officer. Our Manager is an affiliate of Starwood Capital Group, a privately-held private equity firm founded and controlled by Mr. Sternlicht.

 

Subsequent Events

 

On April 11, 2014, we issued 22.0 million shares of common stock for gross proceeds of $491.0 million.  In connection with this offering, the underwriters had a 30-day option to purchase an additional 3.3 million shares of common stock, which they exercised in full, resulting in additional gross proceeds of $73.7 million.

 

On May 6, 2014, our board of directors declared a dividend of $0.48 per share for the second quarter of 2014, which is payable on July 15, 2014 to common stockholders of record as of June 30, 2014.

 

Developments During the First Quarter of 2014

 

·                  Completed the spin-off of our SFR segment to our stockholders on January 31, 2014, as described above.

 

·                  Originated a $450.0 million first mortgage and mezzanine construction financing for the development of a 57-story tower containing luxury condominium residences and ground floor retail space in Manhattan, New York of which the Company has funded $26.1 million.

 

·                  Originated a $234.9 million first mortgage and mezzanine construction financing for the development of a mixed-use luxury residential and retail development in the Flushing area of Queens, New York, of which the Company has funded $19.9 million.

 

·                  Co-originated $407.5 million out of a total of $815.0 million of first mortgage and mezzanine financing, which was used to refinance and recapitalize loans the Company had co-originated in October 2012 for the acquisition and redevelopment of a 10-story retail building in the Times Square area of Manhattan, New York, including the addition of a hotel.  The Company’s balance under the prior loans was $210.9 million.  The Company has funded $182.0 million of the financing.

 

·                  Originated and fully funded $197.2 million of first mortgage and mezzanine financing secured by an 89-asset bank branch portfolio in California.

 

·                  Originated a $179.5 million first mortgage and mezzanine loan to finance the acquisition of a premier data center in Philadelphia, Pennsylvania, of which the Company has funded $99.9 million.

 

·                  Originated a $113.5 million first mortgage and mezzanine loan to finance the acquisition of a 31-story class A office tower located in Burbank, California, of which the Company has funded $74.0 million.

 

·                  Named special servicer on three new issue CMBS deals.

 

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·                  Purchased $44.7 million of CMBS, including $38.9 million in new issue B-pieces.

 

·                  Originated new conduit loans of $261.8 million.

 

·                  Received proceeds of $302.5 million from sales of conduit loans.

 

·                  Amended one of our repurchase facilities to upsize available borrowings to $1.0 billion from $550 million, extend the maturity date, allow for additional extension options, reduce pricing and debt-yield thresholds for purchased assets and amend certain financial covenants to contemplate the spin-off of the SFR segment.  Refer to Note 8 of our condensed consolidated financial statements for further discussion.

 

Results of Operations

 

Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013

 

The discussion below is based on accounting principles generally accepted in the United States of America (“GAAP”) and therefore reflects the elimination of certain key financial statement line items related to the consolidation of variable interest entities (“VIEs”), particularly within revenues and other income, as discussed in Note 2 to the condensed consolidated financial statements included herein. For a discussion of our results of operations excluding the impact of Accounting Standards Codification (“ASC”) Topic 810 as it relates to the consolidation of VIEs, refer to the Non-GAAP Financial Measures section herein.

 

Revenues

 

For the three months ended March 31, 2014, total revenues increased $88.0 million to $172.0 million, compared to $84.0 million for the three months ended March 31, 2013. The increase is primarily due to $51.5 million of revenues attributable to LNR (after consolidated VIE eliminations of $34.1 million) and a $34.4 million increase in interest income from loans of our Lending Segment. Revenues of LNR primarily consisted of $34.2 million of servicing fees and $14.0 million of interest income from loans and investment securities (after consolidated VIE eliminations of $22.0 million and $11.8 million, respectively). The $34.4 million increase in interest income from loans reflects a $1.8 billion net increase in loan investments of our Lending Segment between March 31, 2013 and 2014, mainly resulting from new loan originations.

 

Costs and Expenses

 

For the three months ended March 31, 2014, total costs and expenses increased $78.1 million to $119.0 million, compared to $40.9 million for the three months ended March 31, 2013. The increase was primarily due to $56.6 million of costs and expenses attributable to LNR and increases in our Lending Segment of $19.5 million for interest expense, $12.7 million for management fees and $3.1 million for general and administrative expenses, all partially offset by a $10.2 million allocation of management fees and interest to the LNR Segment and a $4.2 million decrease in business combination costs incurred in the prior year period related to the LNR acquisition. Costs and expenses of LNR primarily reflect general and administrative expenses of $39.0 million, the allocated management fees and interest of $10.2 million and depreciation and amortization of $4.6 million. The increase in interest expense reflects our issuance of $1.1 billion total principal amount of 4.6% and 4.0% convertible senior notes in February and July of 2013 and a new term loan facility that we used to replace LNR’s previous senior credit facility in April 2013. The new term loan facility had an initial principal balance of $300 million, which was increased to $673 million in December 2013.  In addition, our borrowings under various repurchase agreements increased $0.8 billion between March 31, 2013 and 2014. The $12.7 million increase in management fees reflects the impacts of (i) the increase in our stockholders’ equity resulting from prior year equity raises, which generated net proceeds of $1.5 billion, partially offset by the spin-off of the SFR segment, (ii) the profitability of the LNR Segment, which generated higher returns on invested capital and (iii) higher manager stock compensation expense on awards granted in the 2014 first quarter.

 

Other Income

 

For the three months ended March 31, 2014, total other income increased $51.8 million to $75.0 million, from $23.2 million for the three months ended March 31, 2013. The increase was primarily due to $73.5 million of other income attributable to LNR (after VIE consolidations of $34.4 million) and a $9.2 million favorable swing in foreign currency gain (loss) in our Lending Segment, both partially offset by a $19.0 million unfavorable swing in gain (loss) on derivatives and a $12.0 million decrease in gains on loans and investments in our Lending Segment. Other income of LNR primarily consisted of $56.0 million of income of consolidated VIEs and a $20.9 million increase in the fair value of mortgage loans held-for-sale, which includes both realized and unrealized net gains after hedging activity on loans originated by LNR’s conduit platform since we elected to apply the fair value option. Income of consolidated VIEs of $56.0 million reflects the fees paid to LNR in its capacity as special servicer for the VIEs, interest income, and

 

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changes in fair value related to LNR’s direct investments in the VIEs (including CMBS and servicing rights).  The $19.0 million unfavorable swing in gain (loss) on derivatives was principally due to $16.0 million of unrealized gains on currency hedges in the 2013 first quarter driven by a deterioration of the European currency markets compared to a $3.0 million loss in the 2014 first quarter.  The $12.0 million decrease in gains on loans and investments was due to a higher volume of CMBS and other investment sales that generated $13.5 million of realized gains in the 2013 first quarter compared to $1.5 million of gains in the 2014 first quarter.

 

Income Tax Provision

 

For the three months ended March 31, 2014, our income tax provision increased $5.0 million to $5.6 million from $0.6 million for the three months ended March 31, 2013. The increase is due to the taxable nature of LNR’s loan servicing and loan conduit businesses which are housed in TRSs.

 

Discontinued Operations

 

Loss from discontinued operations of $1.6 million and $2.3 million for the three months ended March 31, 2014 and 2013, respectively, reflects the results of the expanding SFR segment prior to its January 31, 2014 spin-off to our stockholders.  Refer to Note 3 to our condensed consolidated financial statements included herein for a summary comparison of the results of the SFR segment for the one month it is included in the 2014 first quarter versus the full three months it is included in the 2013 first quarter.

 

Net Income

 

Net income attributable to the Company for the three months ended March 31, 2014 was $120.6 million or $0.60 per diluted share, compared to net income of $62.2 million or $0.46 per diluted share for the three months ended March 31, 2013, reflecting an increase of $58.4 million or $0.14 per diluted share.

 

Non-GAAP Financial Measures

 

Core Earnings is a non-GAAP financial measure. We calculate Core Earnings as GAAP net income (loss) excluding non-cash equity compensation expense, the incentive fee due under our Management Agreement, depreciation and amortization of real estate (to the extent that we own properties), any unrealized gains, losses or other non-cash items recorded in net income for the period, regardless of whether such items are included in other comprehensive income or loss, or in net income. The amount is adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges as determined by our Manager and approved by a majority of our independent directors.

 

We believe that Core Earnings provides an additional measure of our core operating performance by eliminating the impact of certain non-cash expenses and facilitating a comparison of our financial results to those of other comparable REITs with fewer or no non-cash charges and comparison of our own operating results from period to period. Our management uses Core Earnings in this way, and also uses Core Earnings to compute the incentive fee due under our management agreement. The Company believes that its investors also use Core Earnings or a comparable supplemental performance measure to evaluate and compare the performance of the Company and its peers, and as such, the Company believes that the disclosure of Core Earnings is useful to (and expected by) its investors.

 

However, the Company cautions that Core Earnings does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (determined in accordance with GAAP), or an indication of our cash flows from operating activities (determined in accordance with GAAP), a measure of our liquidity, or an indication of funds available to fund our cash needs, including our ability to make cash distributions. In addition, our methodology for calculating Core Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and accordingly, our reported Core Earnings may not be comparable to the Core Earnings reported by other REITs.

 

In assessing the appropriate weighted average diluted share count to apply to Core Earnings for purposes of determining Core earnings per share (“EPS”), management considered the following: (i) in accordance with GAAP, the two-class method was deemed most dilutive; and (ii) under the two-class method, our participating securities were determined to be anti-dilutive and were thus excluded from the denominator.  Because compensation expense related to participating securities is added back for Core Earnings purposes pursuant to the definition above, there is no dilution to Core Earnings resulting from the associated expense recognition.  As a result, we determined that the two-class method, adjusted to include (instead of exclude) participating securities, was the most conservative and appropriate weighted average share count to apply to the calculation.  This method results in diluted weighted average shares totaling 201,756,868.

 

The definition of Core Earnings allows management to make adjustments, subject to the approval of a majority of the independent directors, in non-standard situations where such adjustments are considered appropriate in order for Core Earnings to be calculated in a manner consistent with its definition and objective. We encountered this type of situation during the three months ended March 31, 2014 when a hedged loan was expected to be repaid, but was instead extended.  The series of foreign exchange

 

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forward contracts which hedged this loan were in a loss position on the expected repayment date.  In order to accommodate the revised repayment date, the hedges were extended.  In doing so, the counterparty required that the existing hedges be effectively liquidated.  As a result, for GAAP and Core Earnings purposes, the loss on the hedge is realized, while the corresponding gain on the loan continues as unrealized until the repayment occurs.  In an effort to treat this transaction consistently with similar past transactions, and to match the income statement effects of a hedge with the related hedged item, we modified the definition of Core Earnings to allow for hedged loans and their corresponding hedges to be treated as realized in the same accounting period.

 

Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013

 

The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended March 31, 2014, by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

LNR

 

Single Family
Residential

 

Total

 

Revenues

 

$

120,493

 

$

85,613

 

$

 

$

206,106

 

Costs and expenses

 

(60,449

)

(56,414

)

(1,882

)

(118,745

)

Other income

 

1,517

 

39,125

 

 

40,642

 

Income (loss) from continuing operations before income taxes

 

61,561

 

68,324

 

(1,882

)

128,003

 

Income tax provision

 

(83

)

(5,537

)

 

(5,620

)

Loss from discontinued operations, net of tax

 

 

 

(1,551

)

(1,551

)

Income attributable to non-controlling interests

 

(231

)

 

 

(231

)

Net income (loss) attributable to Starwood Property Trust, Inc.

 

61,247

 

62,787

 

(3,433

)

120,601

 

Add / (Deduct):

 

 

 

 

 

 

 

 

 

Non-cash equity compensation expense

 

7,207

 

 

 

7,207

 

Management incentive fee

 

4,475

 

2,702

 

 

7,177

 

Change in Control Plan

 

 

1,279

 

 

1,279

 

Depreciation and amortization

 

 

282

 

1,540

 

1,822

 

Loan loss allowance

 

497

 

 

 

497

 

Interest income adjustment for securities

 

(402

)

5,459

 

 

5,057

 

(Gains) / losses on:

 

 

 

 

 

 

 

 

 

Loans held-for-sale

 

 

(2,604

)

 

(2,604

)

Securities

 

(363

)

(22,537

)

 

(22,900

)

Derivatives

 

2,443

 

1,963

 

 

4,406

 

Foreign currency

 

(945

)

 

 

(945

)

Earnings from unconsolidated entities

 

 

(71

)

 

(71

)

Core Earnings (Loss)

 

$

74,159

 

$

49,260

 

$

(1,893

)

$

121,526

 

Core Earnings (Loss) per Weighted Average Diluted Share

 

$

0.37

 

$

0.24

 

$

(0.01

)

$

0.60

 

 

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The following table presents our summarized results of operations and reconciliation to Core Earnings for the three months ended March 31, 2013, by business segment (amounts in thousands):

 

 

 

Real Estate
Investment
Lending

 

Single Family
Residential

 

Total

 

Revenues

 

$

84,009

 

$

 

$

84,009

 

Costs and expenses

 

(40,873

)

 

(40,873

)

Other income

 

23,191

 

 

23,191

 

Income from continuing operations before income taxes

 

66,327

 

 

66,327

 

Income tax provision

 

(615

)

 

(615

)

Loss from discontinued operations, net of tax

 

 

(2,288

)

(2,288

)

Income attributable to non-controlling interests

 

(1,181

)

 

(1,181

)

Net income (loss) attributable to Starwood Property Trust, Inc.

 

64,531

 

(2,288

)

62,243

 

Add / (Deduct):

 

 

 

 

 

 

 

Non-cash equity compensation expense

 

4,656

 

 

4,656

 

Management incentive fee

 

47

 

 

47

 

Depreciation and amortization

 

 

713

 

713

 

Loan loss allowance

 

30

 

 

30

 

(Gains) / losses on:

 

 

 

 

 

 

 

Securities

 

(438

)

 

(438

)

Derivatives

 

(16,580

)

 

(16,580

)

Foreign currency

 

7,427

 

 

7,427

 

Core Earnings (Loss)

 

$

59,673

 

$

(1,575

)

$

58,098

 

Core Earnings (Loss) per Weighted Average Diluted Share

 

$

0.44

 

$

(0.01

)

$

0.43

 

 

Real Estate Investment Lending Segment

 

The Lending Segment’s Core Earnings increased by $14.5 million during the first quarter of 2014, from $59.7 million during the first quarter of 2013 to $74.2 million in the first quarter of 2014. After making adjustments for the calculation of Core Earnings, revenues were $119.9 million, costs and expenses were $48.3 million, other income was $2.8 million and income taxes were $0.1 million.

 

Core revenues, consisting principally of interest income on loans, increased by $35.9 million due to significant growth in our loan portfolio.

 

Core costs and expenses increased by $12.1 million in the first quarter of 2014, primarily due to higher interest expense associated with the various facilities utilized to fund the growth of our investment portfolio.  This increase in interest expense was partially offset by the absence of $4.3 million of costs incurred in the first quarter of 2013 associated with the LNR acquisition.  General and administrative expenses increased by $2.8 million during the quarter due to higher legal fees associated with the administration of our financing facilities and higher compensation expense.

 

Core other income decreased by $10.8 million, principally due to lower gains on sales of investments of $11.3 million. The nature and timing of investment sales will depend upon a variety of factors, including our current outlook and strategy with respect to an investment, other available investment opportunities, and market pricing. As a result, gains (or losses) from sales of our investments have fluctuated over time, and we would expect this variability to continue for the foreseeable future.

 

LNR Segment

 

The LNR Segment contributed Core Earnings of $49.3 million during the three months ended March 31, 2014. After making adjustments for the calculation of Core Earnings, revenues were $91.1 million, costs and expenses were $52.2 million, other income was $15.8 million and income taxes were $5.5 million.

 

Core revenues benefited from servicing fees of $56.2 million, CMBS interest income of $28.5 million, interest income on our conduit loans of $2.8 million, and other revenues of $3.6 million. Our U.S. servicing operation earned $43.3 million in fees during the period while our European servicer earned $12.9 million. The treatment of CMBS interest income on a GAAP basis is complicated by

 

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our application of the ASC 810 consolidation rules. In an attempt to treat these securities similar to the trust’s other investment securities, we compute core interest income pursuant to an effective yield methodology. In doing so, we segregate the portfolio into various categories based on the components of the bonds’ cash flows and the volatility related to each of these components. We then accrete interest income on an effective yield basis using the components of cash flows that are reliably estimable. Other minor adjustments are made to reflect management’s expectations for other components of the projected cash flow stream.

 

Included in core costs and expenses were general and administrative expenses of $37.8 million, allocated segment management fees of $5.6 million, direct interest expense of $1.0 million, allocated interest expense of $4.5 million and amortization expense of $4.0 million. Amortization expense principally represents the amortization of the European special servicing intangible, which reflects the deterioration of this asset as fees are earned.

 

Core other income includes profit realized upon securitization of loans by our conduit business, gains on sales of CMBS, gains on derivatives that were either effectively terminated or novated, and earnings from unconsolidated entities. Derivatives include instruments which hedge interest rate risk and credit risk on our conduit loans. For GAAP purposes, the loans, CMBS and derivatives are accounted for at fair value, with all changes in fair value (realized or unrealized) recognized in earnings. The adjustments to Core Earnings outlined above are also applied to the GAAP earnings of our unconsolidated entities.

 

Income taxes principally relate to the operating results of our servicing business and our conduit business, which are held in TRSs.

 

Single Family Residential Segment

 

This segment generated a Core Loss of $1.9 million during the three months ended March 31, 2014 compared to a Core Loss of $1.6 million for the three months ended March 31, 2013.

 

Liquidity and Capital Resources

 

Liquidity is a measure of our ability to meet our cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make new investments where appropriate, pay any dividends to our stockholders, and other general business needs. We closely monitor our liquidity position and believe that we have sufficient current liquidity and access to additional liquidity to meet our financial obligations for at least the next 12 months. Our strategy for managing liquidity and capital resources has not changed since December 31, 2013, other than as set forth below.  Please refer to our Form 10-K for a description of these strategies.

 

Cash and Cash Equivalents

 

As of March 31, 2014, we had cash and cash equivalents of $226.5 million.

 

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Cash Flows for the Three Months Ended March 31, 2014

 

 

 

GAAP

 

VIE
Adjustments

 

Excluding LNR
VIEs

 

Net cash provided by operating activities

 

$

104,324

 

$

24

 

$

104,348

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

Spin-off of SWAY

 

(111,960

)

 

(111,960

)

Purchase of investment securities

 

(9,890

)

(38,105

)

(47,995

)

Proceeds from sales and collections of investment securities

 

36,110

 

48,501

 

84,611

 

Origination and purchase of loans held-for-investment

 

(728,594

)

 

(728,594

)

Proceeds from principal collections and sale of loans

 

462,828

 

 

462,828

 

Acquisition and improvement of single family homes and acquisition of non-performing loans, net of sales proceeds

 

(58,964

)

 

(58,964

)

Net cash flows from other investments and assets

 

7,766

 

(15,280

)

(7,514

)

Decrease in restricted cash, net

 

234

 

 

234

 

Net cash used in investing activities

 

(402,470

)

(4,884

)

(407,354

)

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

Borrowings under financing agreements

 

997,767

 

 

997,767

 

Principal repayments on borrowings

 

(656,573

)

 

(656,573

)

Payment of deferred financing costs

 

(7,418

)

 

(7,418

)

Payment of dividends

 

(90,171

)

 

(90,171

)

Distributions to non-controlling interests

 

(31,788

)

 

(31,788

)

Issuance of debt of consolidated VIEs

 

45,761

 

(45,761

)

 

Repayment of debt of consolidated VIEs

 

(53,385

)

53,385

 

 

Distributions of cash from consolidated VIEs

 

2,740

 

(2,740

)

 

Net cash provided by financing activities

 

206,933

 

4,884

 

211,817

 

Net decrease in cash and cash equivalents

 

(91,213

)

24

 

(91,189

)

Cash and cash equivalents, beginning of period

 

317,627

 

(276

)

317,351

 

Effect of exchange rate changes on cash

 

57

 

 

57

 

Cash and cash equivalents, end of period

 

$

226,471

 

$

(252

)

$

226,219

 

 

The discussion below is on a non-GAAP basis, after removing adjustments principally resulting from the consolidation of LNR’s VIEs under ASC 810. These adjustments principally relate to (i) purchase of CMBS related to consolidated VIEs, which are reflected as repayments of VIE debt on a GAAP basis and (ii) sales of CMBS related to consolidated VIEs, which are reflected as VIE distributions on a GAAP basis. There is no net impact to cash flows from operations or to overall cash resulting from these consolidations. Refer to Note 2 of our condensed consolidated financial statements for further discussion.

 

Cash and cash equivalents decreased by $91.2 million during the three months ended March 31, 2014, primarily due to the spin-off of SWAY. Cash provided by operating activities of $104.3 million, was essentially offset by cash used in investing activities of $407.4 million, excluding the SWAY spin-off, being $83.6 million in excess of the cash raised by financing activities of $211.8 million as the Company raises cash strictly to fund new investments.

 

Net cash provided by operating activities for the three months ended March 31, 2014 totaled $104.3 million and related primarily to cash interest income of $141.8 million from our loan origination and conduit programs, plus cash interest income on investment securities of $38.2 million. Servicing fees provided cash of $56.2 million and other revenues provided $3.3 million. Offsetting these revenues were general and administrative expenses of $34.1 million, a net change in operating assets and liabilities of $49.4 million, cash interest expense of $44.6 million and management fees of $7.0 million.

 

Net cash used in investing activities for the three months ended March 31, 2014 totaled $407.4 million and related primarily to the acquisition and origination of new loans of $728.6 million, $112.0 million distributed in connection with the SWAY spin-off, the acquisition and improvement of real estate and non-performing residential loans of $59.0 million, and net investments in derivatives and other investments of $7.5 million.  Offsetting the new investment purchases were proceeds received from principal repayments and sales of loans of $462.8 million and proceeds from sales and collections on investment securities exceeding purchases of investment securities by $36.6 million.

 

Net cash provided by financing activities for the three months ended March 31, 2014 totaled $211.8 million and related primarily to net borrowings after repayments on our secured debt of $333.8 million, partially offset by dividend distributions of $90.2 million and distributions to non-controlling entities of $31.8 million.

 

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Table of Contents

 

Cash Flows for the Three Months Ended March 31, 2013

 

Cash and cash equivalents decreased by $4.6 million during the three months ended March 31, 2013.  The decrease resulted from cash provided by operating activities of $84.9 million and cash provided by financing activities of $191.8 million, offset by cash used in investing activities of $281.2 million.

 

Net cash provided by operating activities for the three months ended March 31, 2013 of $84.9 million reflects primarily net income of $63.4 million and changes in operating assets and liabilities of $52.9 million, all partially reduced by a $16.3 million change in fair value of derivatives (principally gains on currency hedges) and $15.0 million of gains on non-performing loans and sales of investments.

 

Net cash used in investing activities for the three months ended March 31, 2013 totaled $281.2 million and related primarily to the acquisition and origination of new loans held-for-investment of $129.8 million, acquisition and improvement of single family homes of $114.9 million, purchase of non-performing loans of $104.1 million, LNR acquisition deposit of $40.7 million, increase in restricted cash of $38.0 million and net purchases of investment securities of $17.7 million, offset by principal collections on loans and investment securities of $93.6 million and $21.7 million, respectively and proceeds from sale of loans of $44.6 million.

 

Net cash provided by financing activities for the three months ended March 31, 2013 related primarily to borrowings from our convertible senior notes of $587.7 million and borrowings from our secured financing facilities of $347.5 million, offset by dividend payments to our shareholders of $73.8 million, repayments on borrowings of $625.5 million, and distributions to non-controlling interests of $44.1 million.

 

Our Investment Portfolio

 

Lending Segment

 

The following table sets forth the amount of each category of investments we owned across various property types within our Lending Segment as of March 31, 2014 (amounts in thousands):

 

Investment

 

Face
Amount

 

Carrying
Value

 

%
Owned

 

Asset Specific
Financing

 

Net
Investment

 

Weighted
Average
Rating

 

Vintage

 

First mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan acquisitions

 

$

339,225

 

$

313,792

 

100

%

$

194,579

 

$

119,213

 

N/A

 

1989-2014

 

Loan originations

 

2,512,726

 

2,486,773

 

100

%

1,348,222

 

1,138,551

 

N/A

 

2009-2014

 

Total first mortgages

 

2,851,951

 

2,800,565

 

 

 

1,542,801

 

1,257,764

 

 

 

 

 

Subordinated mortgage loans and mezzanine loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan acquisitions

 

406,984

 

367,676

 

100

%

21,422

 

346,254

 

N/A

 

1999-2014

 

Loan originations

 

1,466,562

 

1,461,260

 

100

%

43,427

 

1,417,833

 

N/A

 

2009-2014

 

Total subordinated debt

 

1,873,546

 

1,828,936

 

 

 

64,849

 

1,764,087

 

 

 

 

 

Loan loss allowance

 

 

 

(4,481

)

 

 

 

 

(4,481

)

 

 

 

 

Loans transferred as secured borrowings

 

143,069

 

143,042

 

100

%

143,038

 

 

N/A

 

N/A

 

RMBS—AFS(1)

 

388,066

 

291,217

 

100

%

159,427

 

131,790

 

B-

 

2003-2007

 

CMBS—AFS(1)

 

100,870

 

113,477

 

100

%

 

113,477

 

BB+

 

2012-2013

 

HTM securities(2)

 

371,700

 

369,152

 

100

%

58,467

 

310,685

 

N/A

 

2013

 

Equity security

 

15,229

 

15,115

 

100

%

 

15,115

 

N/A

 

N/A

 

Investments in unconsolidated entities

 

46,395

 

46,395

 

100

%

 

46,395

 

N/A

 

N/A

 

 

 

$

5,790,826

 

$

5,603,418

 

 

 

$

1,968,582

 

$

3,634,832

 

 

 

 

 

 


(1)                                 RMBS and CMBS available-for-sale (“AFS”) securities.

 

(2)                                 Mandatorily redeemable preferred equity interests in commercial real estate entities and CMBS held-to-maturity (“HTM”).

 

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Table of Contents

 

As of March 31, 2014, our Lending Segment’s investment portfolio, excluding other investments, had the following characteristics based on carrying values:

 

Collateral Property Type

 

 

 

Office

 

34.4

%

Hospitality

 

24.4

%

Mixed Use

 

6.7

%

Retail

 

7.8

%

Residential

 

5.4

%

Industrial

 

2.8

%

Multi-family

 

8.8

%

Other

 

9.7

%

 

 

100.0

%

 

Geographic Location

 

 

 

West

 

26.7

%

North East

 

18.6

%

South East

 

13.2

%

International

 

15.3

%

Mid Atlantic

 

10.4

%

South West

 

4.5

%

Midwest

 

5.5

%

Other

 

5.8

%

 

 

100.0

%

 

The following table sets forth the amount of each category of investments we owned across various property types within our Lending Segment as of December 31, 2013 (amounts in thousands):

 

Investment

 

Face
Amount

 

Carrying
Value

 

%
Owned

 

Asset Specific
Financing

 

Net
Investment

 

Weighted
Average
Rating

 

Vintage

 

First mortgages:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan acquisitions

 

$

565,405

 

$

538,777

 

100

%

$

264,855

 

$

273,922

 

N/A

 

1989 - 2013

 

Loan originations

 

2,264,809

 

2,245,297

 

100

%

1,185,115

 

1,060,182

 

N/A

 

2009 - 2013

 

Total first mortgages

 

2,830,214

 

2,784,074

 

 

 

1,449,970

 

1,334,104

 

 

 

 

 

Subordinated mortgage loans and mezzanine loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan acquisitions

 

391,899

 

351,773

 

100

%

2,000

 

349,773

 

N/A

 

1999 - 2012

 

Loan originations

 

1,396,759

 

1,399,489

 

100

%

2,000

 

1,397,489

 

N/A

 

2009 - 2013

 

Total subordinated debt

 

1,788,658

 

1,751,262

 

 

 

4,000

 

1,747,262

 

 

 

 

 

Loan loss allowance

 

 

(3,984

)

 

 

 

(3,984

)

N/A

 

N/A

 

RMBS—AFS(1)

 

414,020

 

296,236

 

100

%

127,943

 

168,293

 

B-

 

2003 - 2007

 

CMBS—AFS(1)

 

100,648

 

114,346

 

100

%

 

114,346

 

BB+

 

2012 - 2013

 

HTM securities(2)

 

371,700

 

368,318

 

100

%

58,467

 

309,851

 

N/A

 

2013

 

Equity security

 

15,133

 

15,247

 

100

%

 

15,247

 

N/A

 

N/A

 

Investments in unconsolidated entities

 

50,167

 

50,167

 

100

%

 

50,167

 

N/A

 

N/A

 

 

 

$

5,570,540

 

$

5,375,666

 

 

 

$

1,640,380

 

$

3,735,286

 

 

 

 

 

 


(1)                                 RMBS and CMBS available-for-sale (“AFS”) securities.

 

(2)                                 Mandatorily redeemable preferred equity interests in commercial real estate entities and CMBS held-to-maturity (“HTM”).

 

As of December 31, 2013, our Lending Segment’s investment portfolio, excluding other investments, had the following characteristics based on carrying values:

 

Collateral Property Type

 

 

 

Office

 

27.2

%

Hospitality

 

25.6

%

Mixed Use

 

16.9

%

Retail

 

11.7

%

Residential

 

9.6

%

Industrial

 

1.8

%

Multi-family

 

1.3

%

Other

 

5.9

%

 

 

100.0

%

 

Geographic Location

 

 

 

West

 

25.7

%

North East

 

20.8

%

South East

 

17.7

%

International

 

15.4

%

Mid Atlantic

 

9.1

%

South West

 

6.0

%

Midwest

 

5.3

%

 

 

100.0

%

 

55



Table of Contents

 

LNR Segment

 

The following table sets forth the amount of each category of investments we owned within our LNR Segment as of March 31, 2014 and December 31, 2013 (amounts in thousands):

 

 

 

Face
Amount

 

Carrying
Value

 

Asset
Specific
Financing

 

Net
Investment

 

March 31, 2014

 

 

 

 

 

 

 

 

 

CMBS, fair value option

 

$

3,857,492

 

$

564,818

(1)

$

 

$

564,818

 

Servicing rights intangibles

 

N/A

 

245,032

(2)

 

245,032

 

Loans held-for-sale, fair value option

 

181,450

 

186,837

 

108,533

 

78,304

 

Loans held-for-investment

 

14,299

 

9,903

 

 

9,903

 

Investments in unconsolidated entities

 

N/A

 

61,601

 

 

61,601

 

Total Investments

 

$

4,053,241

 

$

1,068,191

 

$

108,533

 

$

959,658

 

December 31, 2013

 

 

 

 

 

 

 

 

 

CMBS, fair value option

 

$

3,871,803

 

$

550,282

(1)

$

 

$

550,282

 

Servicing rights intangibles

 

N/A

 

257,736

(2)

 

257,736

 

Loans held-for-sale, fair value option

 

209,099

 

206,672

 

129,843

 

76,829

 

Loans held-for-investment

 

17,144

 

12,781

 

 

12,781

 

Investments in unconsolidated entities

 

N/A

 

76,170

 

 

76,170

 

Total Investments

 

$

4,098,046

 

$

1,103,641

 

$

129,843

 

$

973,798

 

 


(1)         Includes $430.7 million and $409.3 million of CMBS reflected in “VIE liabilities” in accordance with ASC 810 as of March 31, 2014 and December 31, 2013, respectively.

(2)         Includes $77.0 million and $80.6 million of servicing rights intangibles reflected in “VIE assets” in accordance with ASC 810 as of March 31, 2014 and December 31, 2013, respectively.

 

New Credit Facilities

 

In January 2014, we amended one of our repurchase facilities to (i) upsize available borrowings to $1.0 billion from $550 million; (ii) extend the maturity date for loan collateral to January 2019 and for CMBS collateral to January 2016, each from August 2014, and each assuming initial extension options; (iii) allow for up to four additional one-year extension options with respect to any loan collateral that remains financed at maturity, in an effort to match the term of the maturity dates of these assets; (iv) reduce pricing and debt-yield thresholds for purchased assets; and (v) amend certain financial covenants to contemplate the spin-off of the SFR segment.  STWD guarantees certain of the obligations of the consolidated subsidiary, which is the borrower under the repurchase agreement, up to a maximum liability of either 25% or 100% of the then-currently outstanding repurchase price of purchased assets, depending upon the type of asset being financed.

 

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Table of Contents

 

Borrowings under Various Financing Arrangements

 

The following table is a summary of our financing facilities as of March 31, 2014 (dollar amounts in thousands):

 

 

 

Facility
Type

 

Revolver

 

Eligible
Assets

 

Current
Maturity

 

Extended
Maturity(a)

 

Pricing

 

Pledged
Asset
Carrying
Value

 

Maximum
Facility
Size

 

Outstanding
balance

 

Approved
but
Undrawn
Capacity(b)

 

Unallocated
Financing
Amount(c)

 

Lender 1 Repo 1

 

Repurchase

 

Yes

 

Identified Loans and CMBS

 

(d)

 

(d)

 

LIBOR + 1.85% to 5.25%

 

$

1,257,467

 

$

1,000,000

 

$

810,081

 

$

 

$

189,919

 

Lender 1 Repo 2

 

Repurchase

 

Yes

 

Identified RMBS

 

(e)

 

N/A

 

LIBOR + 1.90%

 

267,464

 

175,000

 

159,427

 

1,002

 

14,571

 

Lender 1 Repo 3

 

Repurchase

 

No

 

Identified Loans

 

Dec 2014

 

Dec 2016

 

LIBOR + 2.75%

 

209,427

 

153,299

 

153,299

 

 

 

Lender 2 Repo 1

 

Repurchase

 

Yes

 

Identified Loans

 

Oct 2015

 

Oct 2018

 

LIBOR + 2.00% to 2.75%

 

211,684

 

225,000

 

136,018

 

 

88,982

 

Lender 3 Repo 1

 

Repurchase

 

No

 

Identified Loans

 

Jul 2015

 

Jul 2017

 

LIBOR + 3.00%

 

76,847

 

49,862

 

49,862

 

 

 

Conduit I

 

Repurchase

 

Yes

 

Identified Loans

 

Sep 2014

 

Sep 2014

 

LIBOR + 2.20%

 

112,720

 

250,000

 

80,633

 

 

169,367

 

Conduit II

 

Repurchase

 

Yes

 

Identified Loans

 

Nov 2014

 

Nov 2014

 

LIBOR + 2.10%

 

37,307

 

150,000

 

27,900

 

 

122,100

 

Lender 4 Repo 1

 

Repurchase

 

No

 

Identified Loans

 

Oct 2015

 

Oct 2017

 

LIBOR + 2.60%

 

444,793

 

349,902

 

349,902

 

 

 

Lender 5 Repo 1

 

Repurchase

 

No

 

Identified CMBS

 

Dec 2014

 

Dec 2014

 

LIBOR + 2.00%

 

84,161

 

58,467

 

58,467

 

 

 

Borrowing Base

 

Bank Credit Facility

 

Yes

 

Identified Loans

 

Sep 2015

 

Sep 2017

 

LIBOR + 3.25%(f)

 

869,527

 

250,000

 

107,769

 

 

142,231

 

Term Loan

 

Syndicated Facility

 

No

 

Specifically Identified Assets

 

Apr 2020

 

Apr 2020

 

LIBOR + 2.75%(f)

 

2,568,446

 

670,116

 

667,704

(g)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

6,139,843

 

$

3,331,646

 

$

2,601,062

 

$

1,002

 

$

727,170

 

 


(a)                                      Subject to certain conditions as defined in the respective facility agreement.

 

(b)                                     Approved but undrawn capacity represents the total draw amount that has been approved by the lender related to those assets that have been pledged as collateral, less the drawn amount.

 

(c)                                      Unallocated financing amount represents the maximum facility size less the total draw capacity that has been approved by the lender.

 

(d)                                     Maturity date for borrowings collateralized by loans of January 2017 before extension options and January 2019 assuming initial extension options.  Maturity date for borrowings collateralized by CMBS of January 2015 before extension options and January 2016 assuming initial extension options.

 

(e)                                      The date that is 180 days after the buyer delivers notice to seller, subject to a maximum date of March 13, 2015.

 

(f)                                       Subject to borrower’s option to choose alternative benchmark based rates pursuant to the terms of the credit agreement. The Term Loan is also subject to a 75 basis point floor.

 

(g)                                      Term loan outstanding balance is net of $2.4 million of unamortized discount.

 

Variance between Average and Quarter-End Credit Facility Borrowings Outstanding

 

The following table compares the average amount of repurchase transactions outstanding during each quarter and the amount of repurchase transactions outstanding as of the end of each quarter, together with an explanation of significant variances:

 

Quarter Ended

 

Quarter-End
Balance
(in 000’s)

 

Weighted-Average
Balance
During Quarter
(in 000’s)

 

Variance
(in 000’s)

 

Explanations
for Significant
Variances

 

December 31, 2013

 

2,257,560

 

1,850,572

 

406,988

 

(a)

 

March 31, 2014

 

2,601,062

 

2,536,926

 

64,136

 

(b)

 

 


(a)         Variance primarily due to the following: (i) $375.0 million in proceeds from the upsize of the Term Loan in December 2013, and (ii) $86.1 million draw on the Borrowing Base facility.

 

(b)         Variance primarily due to the following:  (i) $281.6 million in draws on the Lender 1 Repo 1 facility subsequent to its upsizing in January 2014; partially offset by (ii) $146.0 million repayment on the Borrowing Base facility in March 2014.

 

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Table of Contents

 

Scheduled Principal Repayments on Investments and Overhang on Financing Facilities

 

The following scheduled and/or projected principal repayments on our investments were based upon the amounts outstanding and contractual terms of the financing facilities in effect as of March 31, 2014 (amounts in thousands):

 

 

 

Scheduled
Principal
Repayments
on Loans

 

Scheduled/Projected
Principal Repayments
on RMBS and CMBS

 

Projected Required
Repayments of
Financing

 

Scheduled Principal
Inflows Net of
Financing Outflows

 

Second Quarter 2014

 

$

191,990

 

$

29,653

 

$

(112,644

)

$

108,999

 

Third Quarter 2014

 

19,739

 

13,668

 

(11,343

)

22,064

 

Fourth Quarter 2014

 

71,956

 

22,229

 

(87,954

)

6,231

 

First Quarter 2015

 

20,743

 

34,939

 

(163,548

)(1)

(107,866

)

Total

 

$

304,428

 

$

100,489

 

$

(375,489

)

$

29,428

 

 


(1)                                 Approximately $159.4 million of the projected required repayments in the first quarter of 2015 relate to our Lender 1 Repo 2 facility.

 

Issuances of Equity Securities

 

We may raise funds through capital market transactions by issuing capital stock. There can be no assurance, however, that we will be able to access the capital markets at any particular time or on any particular terms. We have authorized 100,000,000 shares of preferred stock and 500,000,000 shares of common stock. At March 31, 2014, we had 100,000,000 shares of preferred stock available for issuance and 303,288,478 shares of common stock available for issuance.

 

Subsequent to March 31, 2014, we issued additional common stock under our currently effective shelf registration.  Refer to Note 23 of the condensed consolidated financial statements included herein for further details.

 

Other Potential Sources of Financing

 

In the future, we may also use other sources of financing to fund the acquisition of our target assets, including other secured as well as unsecured forms of borrowing and/or sale of certain investment securities which no longer meet our return requirements. We may also seek to raise further equity capital, issue debt securities or liquidate investment securities which no longer meet our return requirements in order to fund our future investments.

 

Off-Balance Sheet Arrangements

 

We have relationships with unconsolidated entities and/or financial partnerships, such as entities often referred to as SPEs or VIEs. We are not obligated to provide, nor have we provided, any financial support for any SPEs or VIEs. As such, the risk associated with our involvement is limited to the carrying value of our investment in the entity. Refer to Note 13 to our condensed consolidated financial statements for further discussion.

 

Dividends

 

We intend to continue to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to continue to pay regular quarterly dividends to our stockholders in an amount approximating our net taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating and debt service requirements. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. Please refer to our Form 10-K for a detailed dividend history.

 

On February 24, 2014, our board of directors declared a dividend of $0.48 per share for the first quarter of 2014, which was paid on April 15, 2014 to common stockholders of record as of March 31, 2014.

 

On May 6, 2014, our board of directors declared a dividend of $0.48 per share for the second quarter of 2014, which is payable on July 15, 2014 to common stockholders of record as of June 30, 2014.

 

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Table of Contents

 

Leverage Policies

 

Our strategies with regards to use of leverage have not changed significantly since December 31, 2013.  Please refer to our Form 10-K for a description of our strategies regarding use of leverage.

 

Contractual Obligations and Commitments

 

Contractual obligations as of March 31, 2014 are as follows (amounts in thousands):

 

 

 

Total

 

Less than
1 Year

 

1 to 3 years

 

3 to 5 years

 

More than
5 years

 

Secured financings

 

$

2,603,473

 

$

375,489

 

$

407,470

 

$

1,184,243

 

$

636,271

 

Convertible senior notes

 

1,060,000

 

22

 

 

1,059,978

 

 

Secured borrowings on transferred loans(a)

 

143,069

 

13,676

 

1,439

 

127,954

 

 

Loan funding obligations

 

1,840,745

 

900,289

 

922,238

 

18,218

 

 

Future lease commitments

 

41,780

 

6,440

 

12,263

 

11,448

 

11,629

 

Total

 

$

5,689,067

 

$

1,295,916

 

$

1,343,410

 

$

2,401,841

 

$

647,900

 

 


(a)                                 These amounts relate to financial asset sales that were required to be accounted for as secured borrowings. As a result, the assets we sold remain on our consolidated balance sheet for financial reporting purposes. Such assets are expected to provide match funding for these liabilities.

 

The table above does not include amounts due under our Management Agreement or derivative agreements as those contracts do not have fixed and determinable payments.

 

Critical Accounting Estimates

 

Refer to the section of our Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” for a full discussion of our critical accounting estimates.  Our critical accounting estimates have not materially changed during the three months ended March 31, 2014.

 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.  Our strategies for managing risk and our exposure to such risks have not changed materially since December 31, 2013.  Refer to our Form 10-K Item 7A for further discussion.

 

Market Risks

 

Our loans and investments are subject to credit risk. The performance and value of our loans and investments depend upon the owners’ ability to operate the properties that serve as our collateral so that they produce cash flows adequate to pay interest and principal due to us. To monitor this risk, our Manager’s asset management team reviews our investment portfolios and in certain instances is in regular contact with our borrowers, monitoring performance of the collateral and enforcing our rights as necessary.

 

Our RMBS portfolio had a weighted average Standard and Poor’s rating of B-, as of both March 31, 2014 and December 31, 2013.  Our CMBS fair value option portfolio, including CMBS eliminated in consolidation pursuant to ASC 810, had a weighted average Standard and Poor’s rating of CC, as of both March 31, 2014 and December 31, 2013.

 

As of March 31, 2014, we had not elected the fair value option for the following CMBS (1) $112.5 million of an available-for-sale CMBS rated BB+, (2) $84.2 million of a held-to-maturity CMBS rated BB-, and (3) a $1.0 million interest-only debt security rated BBB-.

 

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Capital Market Risks

 

We are exposed to risks related to the equity capital markets, and our related ability to raise capital through the issuance of our common stock or other equity instruments. We are also exposed to risks related to the debt capital markets, and our related ability to finance our business through borrowings under repurchase obligations or other debt instruments. As a REIT, we are required to distribute a significant portion of our taxable income annually, which constrains our ability to accumulate operating cash flow and therefore requires us to utilize debt or equity capital to finance our business. We seek to mitigate these risks by monitoring the debt and equity capital markets to inform our decisions on the amount, timing, and terms of capital we raise.

 

Foreign Currency Risk

 

We intend to hedge our currency exposures in a prudent manner. However, our currency hedging strategies may not eliminate all of our currency risk due to, among other things, uncertainties in the timing and/or amount of payments received on the related investments, and/or unequal, inaccurate, or unavailability of hedges to perfectly offset changes in future exchange rates. Additionally, we may be required under certain circumstances to collateralize our currency hedges for the benefit of the hedge counterparty, which could adversely affect our liquidity.

 

Consistent with our strategy of hedging foreign currency exposure on certain investments, we typically enter into a series of forwards to fix the USD amount of GBP and EUR-denominated cash flows (interest and principal payments) we expect to receive from our GBP and EUR-denominated loan and CMBS investments. The following table represents our current currency hedge exposure as it relates to our loan investments and a CMBS investment denominated in foreign currencies, along with the aggregate notional amount of the hedges in place (amounts in thousands except for number of contracts, using the March 31, 2014 GBP spot rate of 1.6662 and EUR spot rate of 1.3768):

 

Carrying Value of
Investment

 

Local
Currency

 

Number of foreign
exchange contracts

 

Aggregate Notional Value
of Hedges Applied

 

Expiration Range of Contracts

 

$

 9,889

 

GBP

 

15

 

$

11,872

 

April 2014 - March 2016

 

112,468

 

GBP

 

4

 

123,215

 

September 2014 - March 2016

 

26,644

 

GBP

 

11

 

30,513

 

April 2014 - August 2016

 

31,040

 

EUR

 

2

 

33,189

 

May 2014

 

98,785

 

GBP

 

13

 

129,761

 

April 2014 - April 2017

 

49,794

 

GBP

 

8

 

62,165

 

April 2014 - January 2016

 

65,150

 

EUR

 

22

 

74,966

 

April 2014 - October 2016

 

1,745

 

GBP

 

1

 

4,169

 

March 2015

 

81,944

 

EUR

 

1

 

83,085

 

April 2014

 

15,114

 

GBP

 

17

 

19,493

 

April 2014 - January 2018

 

 

Item 4.    Controls and Procedures.

 

Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including the Chief Executive Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

Changes in Internal Control Over Financial Reporting.  No change in internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the quarter ended March 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 1.    Legal Proceedings.

 

Currently, no material legal proceedings are pending, threatened, or to our knowledge, contemplated against us.

 

Item 1A.    Risk Factors.

 

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3.    Defaults Upon Senior Securities.

 

None.

 

Item 4.    Mine Safety Disclosures.

 

Not applicable.

 

Item 5.    Other Information.

 

None.

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

STARWOOD PROPERTY TRUST, INC.

 

 

 

Date: May 6, 2014

By:

/s/ BARRY S. STERNLICHT

 

 

Barry S. Sternlicht
Chief Executive Officer
Principal Executive Officer

 

 

 

Date: May 6, 2014

By:

/s/ PERRY STEWART WARD

 

 

Perry Stewart Ward
Chief Financial Officer, Treasurer and
Principal Financial Officer

 

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Table of Contents

 

Item 6.  Exhibits.

 

(a)         Index to Exhibits

 

INDEX TO EXHIBITS

 

Exhibit No.

 

Description

 

 

 

3.1

 

Bylaws of Starwood Property Trust, Inc. (Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed March 17, 2014)

 

 

 

31.1

 

Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

31.2

 

Certification pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002

 

 

 

32.1

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

32.2

 

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

63