Kameleon007
Starwood Property Trust, Inc. (NYSE:STWD) investors had a scare early last week as the diversified real estate investment trust or REIT reported its FQ4'22 earnings report.
While the company met the consensus estimates on its distributed EPS, it was cautious about the forward outlook, given the Fed's aggressive rate hikes.
Moreover, with the Fed expected to tune up its hawkish posture, given elevated inflation readings and the strength of the US economy, earnings growth could stutter as its investment growth cadence slowed.
Accordingly, Starwood posted just $1.2B in investment activity in Q4, despite posting a full-year metric of $10.7B for FY22. Management also updated that it would remain defensive until there's more clarity over the Fed's hiking posture, as bid-ask spreads remain wide.
Moreover, the company faced some pretty significant headwinds in its office segment. Notably, it downgraded four office loans worth $724M from a rating of 3 to 4, on top of a retail loan downgrade from a rating of 4 to 5.
However, the company did not indicate a specific loan loss reserve provision as management is confident that "these assets are fully recoverable." Despite that, the company did not rule out a deterioration in the loan loss metrics, suggesting investors must pay attention to potential earnings hit moving forward.
Notwithstanding, Starwood emphasized that it has curtailed its office exposure significantly, given the current downturn, worsened by the persistence of remote/hybrid working. As such, office loans accounted for 13.6% of its assets in Q4.
Hence, we believe the sentiment over STWD in the near term should remain cagey as investors assess whether the Fed's actions will further impact its commercial and residential lending portfolio.
Commercial lending remains the company's main driver in its investment activity for FY22, accounting for $5.3B in full-year originations.
Still, the Fed's rate hikes have benefited Starwood, as 99% of its commercial portfolio is pegged to floating rates.
However, management highlighted that "borrowers have caps in place and can pay until loan maturity." As such, it also drew a sharp question from one of the analysts on the conference call, who was concerned about how flexible Starwood's borrowers are when their rate cap expires.
Management was cautious in its response, suggesting that Starwood would strike a balance with the right borrowers while having clearly-defined guidelines to safeguard its interests. Management highlighted:
It depends a lot on how we have it financed and how our senior partner, whether it's a bank or a CLO, what they want us to do or require us to do, whether they're forcing us to have a new rate cap bought in, what strike that new rate capacity brought in, they're very expensive, as you know, or whether they'll allow us to take interest reserves or other guarantees towards that. So with our premier borrowers, we're certainly open to talking about the different potential solutions in a very difficult rate cap environment. But a lot of times, it's set by where our senior lender requires us to do, and we will hold the line to what the senior lenders do. Our senior lenders are tremendously important to the success of the business. (Starwood FQ4'22 earnings call)
As such, we think the market conditions remain fluid. With the Fed's rate hikes potentially causing more stress on Starwood's portfolio, investors should continue to expect volatility as investors parse the impact on the REIT's ability to drive near-to-medium-term distributable EPS growth.
STWD price chart (weekly) (TradingView)
With that in mind, investors should be cautious about adding close to its February highs, as its previous recovery was rejected decisively before the recent pullback.
However, STWD appears to continue its bottoming process robustly, suggesting that the worst has likely been priced in at its October lows.
Hence, we believe market operators have started to buy significant dips (like the one last week), with a re-test of its February highs subsequently looking increasingly likely.
While we would have preferred a pullback from last week's price action, STWD's NTM dividend yield of 9.25% (Vs. 10Y average of 8.8%) suggests that it's still reasonably valued.
Rating: Buy (Reiterated).
