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Starwood Property Trust Inc. (STWD) Q3 2017 Earnings Conference Call Transcript

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Starwood Property Trust, Inc. (NYSE: STWD)
Q3 2017 Earnings Conference Call
Nov. 8, 2017, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the Starwood Property Trust third quarter 2017 earnings call. Today's conference is being recorded. For opening remarks, I will now turn the conference over to Zach Tanenbaum, Director of Investor Relations. Zach, please go ahead.

Zach Tanenbaum -- Director of Investor Relations

Thank you, Operator. Good morning and welcome to Starwood Property Trust's earnings call. This morning, the company released its financial results for the quarter ended September 30, 2017, filed its form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the investor relations section of the company website at www.starwoodpropertytrust.com.

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

Joining me on the call today are Barry Sternlicht, the company's chief executive officer; Rina Paniry, the company's chief financial officer; Jeff DiModica, the company's president; Andrew Sossen, the company's chief operating officer; and Adam Behlman, the president of our real estate investing and services segment. With that, I am now gonna turn the call over to Rina.

Rina Paniry -- Chief Financial Officer

Thank you, Zach, and good morning, everyone. This quarter, we reported core earnings of $171 million, or $0.65 per share. This amount includes $35 million, or $0.13 per share, from the previously announced sale of a portion of our 10-X investment, which I will discuss shortly. We delivered these results despite a slight drag on earnings from excess cash that we held to repair October 2017 converts. We estimate that the impact was just over $0.02 in the quarter.

I will begin my discussion this morning with the results of our lending segment. During the quarter, this segment contributed core earnings of $112 million, or $0.43 per share. On the commercial lending side of this segment, we originated $937 million of loans, with an 11.3% optimal IRR to spot LIBOR and a 65% LTV. We funded $1 billion, of which $787 million related to new loans and $187 million related to pre-existing loan commitments. Our commercial lending bookended the quarter at $6.8 billion, with an LTV of less than 63%. Repayments totaled $951 million for the quarter, in line with our expectations.

On the residential side of this segment, we acquired $128 million of non-agency loans this quarter, bringing our total portfolio to $419 million and our net equity to $169 million. The current portfolio has an average 62% LTV, an unlevered yield of 5.9%. Our loan book continues to be positively correlated to rising interest rates, with 93% of our commercial portfolio being floating rates. We estimate that a 100 basis point increase in LIBOR would add $0.08 of core earnings annually.

Next, I will discuss our property segment. On September 25th, we added a new portfolio to the segment, bringing its total assets to $2.6 billion. The acquisition was part of a sale lease-backed transaction, where we acquired $425 million of retail assets and $128 million of distribution centers from the recently merged Bass Pro/Cabela's entity. The properties were concurrently leased back to Bass Pro and Cabela's tenants under triple-net mass releases that carry 25-year terms and built-in rent escalations. The assets were levered with 10-year debt at a blended fixed rate of 4.37%. Because the acquisition closed five days before quarter end, it had little impact on core earnings. Jeff and Barry will discuss this portfolio in more detail during their remarks.

Overall, the property segment contributed core earnings of 16 million or $0.06 per share. This is down $0.01 from last quarter, principally as a result of our 33% interest in a regional mall portfolio, for which we did not recognize core earnings in the quarter. In our GAAP results, we recorded a $34 million unrealized loss related to this investment. This relates to a reduction in fair value recorded by the fund vehicle that holds the underlying properties. Because the fund is an investment company under GAAP, the assets it holds must follow a mark to market accounting model, versus the more traditional historical cost model that you typically see when accounting for properties held by REITs and other noninvestment companies. As a result, market movements are reflected in the funds P&L, and our GAAP earnings reflect our 33% share of that P&L.

The markdown recorded by the fund was based on lender appraisal that assumed an as-is liquidation of the property. As with our other unrealized mark to market adjustments, the markdown was added back to core earnings. Despite the markdown, these properties continue to generate positive NOI, are 91% occupied, and have sales per square foot of $558.00. however, this free cash flow is expected to be utilized for capex and for principal amortization on their newly extended debt. We will not be recognizing core earnings related to this investment until operating distributions to the LPs are resumed. Our GAAP investment, inclusive of the unrealized loss and $16 million of funded capital commitments this quarter, is now $110 million, which represents 1% of our total assets and 2% of our equity. The remainder of the assets in this segment, including our Dublin, Woodstar, and medical office portfolios, continue to perform very well, generating consistent returns with a blended aggregate cash on cash yield of 10.5% and a weighted average occupancy of 94%.

I will not turn to our investing and servicing segment, which contributed core earnings of $94 million, or $0.36 per share. The $0.09 increase from last quarter is primarily due to the sale of 88% of our investment in 10-X. As you may recall, last quarter, we recorded a $26 million GAAP gain related to the warrants we hold in 10-X. This quarter, we recorded a $28 million GAAP gain for the common stock portion of our investment. For core purposes, the entirety of the realized gain, which excludes a 12% equity interest that we retained in the acquiring entity, is reflected in the current quarter. The core gain totals $52 million and was offset by income taxes of $18 million. We also capitalized on opportunities to harvest gains in our CMBS portfolio and in the properties that we acquired from the CMBS trust. During the quarter, we recognized net core gains of $8 million related to these assets. We also recognized a $14 million positive mark to market adjustment in our GAAP P&L related to our CMBS, principally as a result of tightening spreads on our double B.

On the servicing front, we saw lower transfers in the servicing than we saw in each of the last two quarters. We also saw fewer resolutions, which drove this quarter's decline in servicing fees. During the quarter, we obtained two new servicing assignments on deals totaling $2.1 billion of collateral, bringing our main servicer portfolio to 153 trusts with a balance of $69 billion. And before leaving this segment, I will say a few words about our conduit, which continues to perform well. This quarter, we securitized $498 million of loans in two securitization transactions. We expect to see similar volume in the fourth quarter.

I will conclude with a few brief comments about our capitalization and fourth quarter dividend. We ended the quarter with $3.8 billion of undrawn debt capacity, a weighted average debt term of 54 months, and a modest debt to undepreciated equity ratio of 1.6 times. If we were to include off-balance sheet leverage in the form of a note sole, our debt to undepreciated equity ratio would be 2.2 times or 2.1 times excluding cash. As our property portfolio continues to become a larger part of our book, we believe that metrics based on undepreciated equity are more meaningful than depreciated GAAP equity and will, therefore, present them to you on this basis going forward. Our historical debt to equity metrics would not have changed using this new approach.

For the fourth quarter, we have declared a $0.48 dividend, which will be paid on January 15 to shareholders of record on December 29. This represents an 8.9% annualized dividend yield on yesterday's closing share price of $21.46. With that, I'll turn the call over to Jeff for his comments.

Jeffrey F. DiModica -- President and Managing Director

Thanks, Rina. We've always run this company with as much focus on the right side of our balance sheet as the left, and capital markets continue to treat us well. We've increased our borrowing capacity significantly in 2017 and at lower rates. We have been able to offset loan spread tightening with cheaper secured and unsecured debt while maintaining on and off-balance sheet leverage ratios significantly below our peer group. The five-year unsecured bonds we issued last December trade at 365 today. That's 3.65% percent, in line with where many investing gray companies trade. Being able to issue unsecured debt inside where others in our state issue convertible bonds is a great advantage, and we will continue that rotation of our capital structure toward unsecured debt.

As Rina said, we recently paid off our October 2017 convertible bonds with cash. We expect to continue to turn out our liabilities by issuing unsecured fixed rate debt, which is very powerful and would allow us to both unencumber our higher cost assets accretively and bid more competitively on a variety of new debt and equity investments. Our lending segment had another strong quarter, and our lending book today at $6.8 billion is the largest it has been in our history, up 32% of $1.7 billion since the first quarter of 2014. Rina mentioned we had significant loan payments in this quarter. 2014 was our highest volume originations year, and if those loans pay off, we expect elevated repayments to continue through the first quarter of 2018, giving us ample near-term dry powder to invest. We are confident in our ability to recycle these assets accretively and expect to continue to do so at equal or higher returns. We will continue to add origination staff to increase lending volumes and take advantage of the opportunities to recycle that capital fully and accretively, as we did this quarter.

Q4 is shaping up to be our largest loan origination quarter in my three-plus years here, with $700 million closed to date and an optimal IRR of up 12%. While base lending spreads have undoubtedly tightened, we have maintained discipline in our lending book. Our loan book today is 82% first mortgages and 42% office, which is up 36% versus 12 months ago. No MSA in our lending book is over 15%, and less than 1% of our loan book is over 80% LTB, which we believe is more important than the 62.8% LTB of our portfolio overall.

Construction lending continues to offer an outsized opportunity for our expertise, our scale, and our capital. We made one construction loan in the quarter for $72 million. We are extremely discriminating in every loan we make, writing less than 5% of the loans we look at, and more so in construction loans. So, despite the opportunity created by HPCRE and the pullback of the traditional lenders, our funded balance of construction loans today as a percentage of our entire loan portfolio is the lowest it's been since we started the strategy four years ago. This provides us ample room to grow that book as opportunities present themselves in the coming months and quarters.

Switching gears to our residential lending platform, we expect our balance of non-agency loans to be over $500 million by year-end. We plan to securitize the majority of these loans in Q1 of 2018. Fortunately, non-agency securitization spreads continue to tighten across the debt sack. Based on the strong credit performance of our loans and where deals are getting done today, we expect to earn higher full-term IRRs on these than our pro forma underwriting.

We have talked before about our preference for experiential retail. As Rina said, commensurate with Bass Pro's acquisition of Cabela's in September, we acquired three industrial and 20 retail locations that will be triple-net master leased for 25 years with inflation-protected rent escalations and a corporate guarantee from Bass Pro. The combined company produces stable cash flow through cycles and is now more diversified across segments, with Bass Pro being bigger in boating and fishing, and Cabela's in hunting and shooting. Cabela's also has an exceptionally durable credit card program that accounted for 73% of its operating income in 2016 and will continue to help drive performance of the combined company. We believe the merger makes great strategic sense and expect there to be substantial synergies realized in the combined company. We were able to purchase these properties at a price we believe is materially lower than where the properties would sell on a one-off basis, and we expect to earn an accretive cash on cash return from day one of this investment that will increase over time.

We financed our investment with 10-year CMBS debt at 48% of cost and expect to earn an accretive cash on cash return of over 11% during that 10-year period. Some of you have never entered a Bass Pro or Cabela's and would be surprised to learn that the average customer spends almost three hours in the store from the time they enter. This is the definition of experiential retail, complete with active exhibits, restaurants, and an extremely loyal patronage that puts great value on the credit card loyalty program. With this purchase, our own real estate across our property and lease segment is now over $3 billion. Additionally, we are in the process of closing an accretive multi-family portfolio that will further increase our property's segment in the coming months. Rina just described a Q3 writedown to our retail JV, an investment that I would note accounts for less than 1% of our assets.

The rest of our property portfolio, which is much more significant in size and contribution, has performed extraordinarily well, with a cash on cash return of over 10.5% and significant unrealized upside across each property type. If we mark those to market today, we conservatively believe that our Dublin office portfolio, Woodstar multifamily portfolio, medical office portfolio, and Reese property portfolio each have gained similar to or greater than the appraisal-driven GAAP writedown we are taking this quarter. En masse, the property segment has done exactly what we hoped when we began that diversification process. Providing current income, duration, depreciation, and significant portfolio level appreciation. In addition to the 10-X gain we took this quarter, we also have two significant equity kickers on our loan book that are carried at zero basis on our financial statements.

I would be remiss not to mention Starwood Mortgage Capital, our CMBS conduit origination business, that continues to perform well in an increasingly competitive lending environment. Many of you have noticed the significant CMBS spread tightening we've witnessed in the past few weeks and months. The world is starved for yield, and CMBS and corporate credit continue to perform very well. We think we have a pretty good yield story too.

Barry mentioned on this call years ago that the holy grail for us was to someday become investment grade. We set a long-term goal to run a diversified real estate finance business of complementary businesses that outperform through cycles and seek value across the spectrum of possible investments. We believe by continuing to add stable equity investments, increasing our unsecured versus secured debt, keeping our leverage significantly lower than our peers, and maintaining laser focus on our liabilities and the credit of our portfolio, that we will continue to lower our borrowing costs, which over time will grow our earnings and our company. We believe we are well on our way. With that, I'll turn it over to Barry.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

Thank you, Zach. Thank you, Rina. Thank you, Jeff. I think we had a really solid quarter, and obviously, I was really bullish last quarter, so you can see the results, and you can see Jeff's optimism, the team's optimism on the pipeline going forward. I was struck as we reviewed the company's evolution by two really fascinating facts. On the loan book, which reached its highest skit size in the history of the firm this quarter, the LTV of the book has actually fallen over the last three years. In 2013, it was 65%, 65.5%, and today, it's 62.8%. And it's kind of remarkable because the dividend yield obviously doesn't reflect the credit of the portfolio. That's the loan book. And then you add in the equity book. And if we were an equity REIT, obviously our dividend would be probably on those assets in the fives, maybe. Maybe the sub-fives, four-and-a-half. So, the stock continues to deliver extraordinary value, and I think we've successfully diversified into these new business lines to fill the gaps that will evolve over time as the servicing book declines. Special kudos again to Larry Brown's team and the conduit business. We've had an exceptional quarter. Continues to -- it's a manufacturing business. They turn their book 11 times a year, so we have never experienced a loss in that business, and now going on nine years.

And our resi business has outperformed even our expectations, and it's growing nicely, very nicely. And we said it'll need to exceed our return expectations. Those were also double-digit on equity. So, we expect to grow that business and continue to grow our equity book, and all at rates kind of similar to the rates we were doing three, four, five years ago. We told everybody that as spreads tighten, our cost of funds borrowings would tighten, and we would be able to preserve our yield. And it's nice to do exactly that. The 11-4 target yield on the portfolio originated last quarter, and in the 60s on an LTV basis, it's just spectacular investing.

Just to go over how we select assets, you may not know, but we are the -- I think the largest or second largest market-rate apartment owner in the United States. And we look in the REIT for stable assets with double-digit cash on cash yields. And there are very few real estate assets that can perform like that. The multi-families, the ones we bought the affordable housing portfolio, we call it the Wilson portfolio -- well, we didn't expect rapid growth because it's affordable housing, but we felt incredibly stable. And if you recall, we financed it with, I think at the time, 17-year debt, fixed debt. So, and the partners here say, would we like to own this forever? And we say, yes. And so, we put it in the REIT. And we expect, since we're gonna own it for a long time, that the IRRs will be in the low double digits and attractive for our core investing and our goal of having consistent dividend yield.

I'll say that our move into Cabela's and to this credit was controversial, but it's actually -- I didn't think it was a retail deal. I thought of it as a credit deal and a distressed credit play, because the market has so kicked retail in the face that this investment actually looks totally compelling. And I don't really care about the stores or where they're located because we have the full credit support of the parent. Bass Pro, as you know, is private. Cabela's was public. As Jeff mentioned, its credit card is receivable. Actually, they had a bank. And the bank was three-quarters of their income. And so, we lent against the bank. The bank is now owned basically by Capital One, but they pay hundreds and hundreds and hundreds of millions of dollars to this combined entity in the form of EBITDA receipts, which actually, it's a bigger portion of their inventory than they make in their stores. So, we loaned against the bank, not against the retailer, in my view. And there'll be hundreds of millions of dollars in synergy. I won't even tell you what the company thought. But the Bass Pro Shop, which was a successful private enterprise, bet the ranch on doing this investment, and so, at RLTC of 40-something %, we were super happy. And with their credit guarantee -- that bank, by the way, or the [inaudible] [00:20:58], it is a private labeled credit card, and Cabela's issues -- only 5% of transactions on that card actually take place in the Cabela's store.

And the company has already successfully migrated online, so if all their stores were to go dark, god forbid, we'd still have their corporate guarantee. And the credit card business, as long as they had an online business, would stay intact. So, we actually think now that they can redeem those points at Bass that that will grow in scale, and so does the company. So, we thought it was a mispriced credit, and we reached up and took advantage of it. And I'm really excited about that, and that's been an opportunity for our -- it was a long live deal. It was kicking around for a long time. And we're not -- we don't really care about the same-store sales, I might add, again, especially if it's migrating online for them because that's higher margin business than even in the stores.

One other thing about hunting is you can't sell rifles online. So, that portion of their business and everything to do with hunting most likely stays in a physical retail store for a long time. As Jeff mentioned, these are three-hours visits. So, we're pretty excited about that. And we're also excited about all of our new businesses, and we're looking at several others in this portfolio that Jeff mentioned, another multi-family portfolio that you'll see announced in the coming weeks. And the multi-family portfolio, they're all in Florida and concentrated in Orlando, a market we know really, really well. And we'll finance it with long-term debt, and then we'll have the double-digit cash on cash yield out of the box, so there'll be no need to pro forma. Double-digit yield will provide that right out of the box with fixed-rate debt.

So, and the other thing is, as Rina mentioned at the top of her comments, is that we didn't run a very efficient book, and we haven't really for most of the year. We've been sitting on a lot of cash. We mentioned the credit markets. And did a big loan refinancing earlier in the year. We sat on a ton of cash to pay off the convert in October. And we hope to run a more optimal book going forward and to continue to look to de-lever our assets or unencumber our assets and issue unsecured debt, which will keep us marching toward an investment grade credit. What's fascinating about it is the debt markets think we're a stud, and the equity markets treat us like we're a junk bond. So, it's a fascinating situation, because our debt has traded great and continues to tighten and tighten, and our stock continues to sort of be a [inaudible], trading at almost a 9% dividend yield.

So, I think it's a ridiculously compelling investment. I've never understood why the stock didn't trade at a 6% dividend yield, given the diversity and where rates are, and the amount of money in the market, and the lack of yield. And we're seeing mezzanines now at 7%, 6.5%, 6%, just pointing down. The yield is going down. So, we have a 62% LTV book, and we traded a 9%. Figure that out. The mezzanines are trading from, what? They go from 60% to 70%, 75% LTV, and they're 7%s. We have a diversified book, but a mound of equity investments in the company, and we traded a 9%. It's sort of preposterous, but anyway. And then we have the embedded gains in the book, which are substantial. And we think our manufacturer would estimate over $1.00 a share of gains net of the small unrealized loss we took this quarter in the Calvin portfolio. So, we're pretty excited about the coming months. The team's jazzed up, and we're cooking on cylinders. We continue to be a major force in the market, being two times the size of our nearest competitor. And we're ramping up and looking aggressively at loans in Europe. We're really trying to build that book up. It basically doesn't exist today, and we're looking at some investments across that sector. That's probably, what, 5% of our assets?

Jeffrey F. DiModica -- President and Managing Director

Yeah, I think it's seven.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

7%, so. Zach's shaking his head. He doesn't think it's 7%. So, 7%. But we'd like to get that back up to like 20%. And what we'd like to see is that loan book, which is $6.9 million or so, grow to $10 billion, right? And that's if we can find these investments. We've just got to keep adding people, and continue to gain market share, and work with the banks, which are our friends and partners and competitors in a very competitive market. It's not exactly a layup out there.

So, there's one other thing, because we don't always say it. The equity book stretches the duration of our investments, and you can see, with $900 million of payoffs, it's awfully nice to have a 30-year book now not rolling over, and earning double-digit yield. It adds great stability to our income stream. So, super happy, and with that, we'll take any questions.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, to ask a question, you may do so by pressing the star key, followed by the digit one on your touchtone phone. If you're on a speakerphone, we recommend that you disengage your mute function or pick up your handset before pressing star one. Again, star one, and we'll pause just a moment. We'll take our first question from Jade Rahmani with KBW.

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

Thanks very much. In terms of risks on the horizon, I wanted to find out if you could share your thoughts on things you worry about and how you expect commercial real estate performance to perform in 2018?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

Yeah. So, I think I worry about what everybody worries about, that the unwind of the stimulus gets a little out of hand. When the government starts selling bonds, they will raise rates in December. Is the economy getting too hot? When rates move too fast, it's actually good for us, but it's not good for general economic activity. So, it'll be good for our earnings. It'll be hard to refinance our debt, so we'll have less payoff, which is great. But I think since we're floating rate, I mean, most of our book, people can -- spreads come in because values are going up because inflation's returned and replacing costs are rising. On the margin, I guess we'd like to see economic activity, and you're seeing it in the country.

But, so risks, undisciplined lending. This foreign capital that's showed up that is powering most of these mezzanine players to buy debt, they're typically East Asian sources of capital. The Chinese are probably backing off a little bit. Certainly, from the equity market, they're backing off completely. But from the debt market, so if they're already committed to a fund, they're in the fund. And the sovereigns haven't shut down their investing. You saw recently, I think it was CIC, said they're gonna put $5 billion into property in the U.S. So, but all of the live companies, they've probably closed for business in the States for a while. So, maybe you're seeing the tail end of some of that wave of money that blew into the country and started to buy these mezzanines and spreads we hadn't seen before.

So, lack of discipline. Right now, you're seeing the market remain fairly disciplined. The government, the federal government, continues to look at the banks, and look at their books, and look at their real estate loans outstanding, and those held. We have seen a few investment banks do equity deals again on their balance sheet, and that was a horrible thing last cycle. Morgan Stanley -- I'll name -- bought its casino. A federally charted bank shouldn't be buying a casino. They bought a development piece of land, outbid us for a piece of land in Jersey City. Since that CEO's no longer, I can say that. In Atlantic City, sorry. And to invest in something, it's doing on their balance sheet, and barring money from the government, at zero, is pathetic. And we've recently seen a few other investment banks get back into the equity business just because they're federally charted banks and they're looking for spread. Don't want to see that. Don't want to see anything like that. And that's a winning bid. We can't compete with that, right? They borrowed, at the window, nothing, and we can't. So, we'd like to see the banks stay banks and not put big real estate deals on their balance sheets to get earnings and yield because their trading operations aren't doing so well.

So, I would say that's a warning. That's a warning sign. It hasn't been a flood. It's been more of a trickle. Something north of a trickle and less than a flood. And I think we're watching the retail complex. Sales, you've seen recently -- yesterday, there was a rumor that general gross was gonna go up by Brookfield. The retail complex is kind of like a bid out place today, right? I mean, the people feel the assets they own or the assets [inaudible] [00:30:06], they're stable. There's turnover in tenants. But the patina of the sector is tough. And we're grateful that our investment represents 1% of our assets, and we're not accruing any income from the investment right now and won't for the foreseeable future as we continue to invest in those properties. But, so it's not our earnings estimates. It's not an issue. But would we like it to perform better? Absolutely. Would we bat 1000%? No. Do we -- net gains in the equity book overall? For sure.

So, I think the retail space, I mean, nobody knows where equilibrium is. But there is -- I think it was one of the companies. I think it was -- I think it might have been GGP, said they signed more leases last year than they've ever signed, the last 12 months. So, there's tenants. It's just, they're different tenants, and you've got the wrong tenant in the mall. It's not the tenants millennials want. And so, you put Warby Parker, and Bonobos, and Box, and you know the guys in your mall, and the kids go. And you put -- unfortunately for them, you put the Gap and the Limited Express, and those are yesterday's brands. It's kind of like Post cereal. Nobody's buying Special K. The same thing's happening in the mall. Our job, again, is to keep the mall as an experience and drive traffic. In the old days, the mall owner did nothing. He just made it clean, and he turned the lights on and the AC. Now you've got to program the mall like you would a concert hall. You've got to bring in events and really pull people off of their couches for the experience. And all the tenants are doing it together. I'd say that the industry understands the pressure it's under.

And so, we're cognizant of -- we're wondering, is this a great opportunity for lending, right? We're not sure in all cases, so we're gonna be super picky and find where we think the right risk/reward place is. We've made a management change at our own management company and brought in Michael Glimcher to run our retail assets. And he's managing those assets, and he's really optimistic. But everyone's under pressure in that space, so. There are -- see, in the department stores is -- the good news is, many of our malls, we want the department stores to go out. They pay us something. Sometimes we don't even own the store. And when we do own the store, they probably pay us $2.00 or $3.00. So, essentially, the land value would be higher as apartments, or a hotel, or an office building, and we're looking at all those JVs for all of our retail assets.

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

On the retail JV, is there any conservatism baked into the writedown you took? And what would be the timeframe for the JV to start providing -- generating operating earnings again?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

If you asked me -- first of all, conservatism, you're taking no income, so that's conservative. And the appraisal is the appraisal, and I think it's fine. It was done for the recent reextension of the debt, which I believe is a two-year extension. I honestly, if we lost one of those investments, it'd be a disaster for me ego-wise, but nothing for the company. So, is that gonna happen? You tell me. I mean, I think these are great assets and great markets. I happen to think the mall -- it's like a patient that's at the doctor getting resuscitated. I mean, it needs a few new organs. And but it's a healthy body, and it will recover. So, they're well-located. They've got great parking. Everybody knows where they are. They've got great access. They're just gonna have to evolve --it's a cliché -- doing more in their team environment to bring people there.

But the whole sector -- will Amazon be the only retailer left in the United States? I have a feeling that municipalities will be very bummed when their main streets are completely empty and they don't know what to do with all the retail stores on Madison Avenue, and Soho, and Michigan Avenue. So, if you think people got upset about the bookstore closing -- and they did movies about that -- wait till they take down every single company in America. Fuck them all. Don't worry about them. Think about Main Street, all across the United States. And people say it's Wal-Mart. It's not Wal-Mart. It's not Wal-Mart. It's different. This is predatory pricing. Their ability to use prime, the prime card and deliver basically below cost wouldn't be legal in other industries. So, in the old days, if you priced aluminum below cost, you got the federal government at your front door. So, this company trades at 100 times EBITDA. I mean, it's game over, right? Nobody trades at 100 times EBITDA. So, there's profits in their AOS business, their cloud business, trying to support an aggressive move against everybody. I mean, CVS, they deliver prescriptions to your house. You tell me where that ends. I'm not smart enough. But I have a feeling somebody's gonna get annoyed here at some point. So, it has nothing to do with us. I'm way off-topic, but you asked, so I answered.

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

On the special servicing side, can you touch on the outlook for 2018 for special servicing? And also on the surveillance and CMBS 2.0 side, given the retail woes, are there any uptick in CMBS 2.0 delinquencies that could potentially provide somewhat of an offset to the special servicing runoff?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

I did want to say one thing. I forgot in my comments. We kind of made a decision to keep our CMBS book at roughly a $1, or 10% of our overall assets for -- that's four or five years, probably. And so, we haven't been -- we've been cherry-picking VP steals. But I was surprised when I looked at our book today, and I think it's probably almost like 85% of our book of that is 2.0 today. And it's not 1.0. So, we're no longer -- that business is kind of already done, essentially, and coming off. And those were good, high-income paper, and we've navigated that transition beautifully. I would say that our -- as we look at our budgets for '18 at this moment in time, we're in better shape than we were going into '17. So, we budget what we can, and so, we're feeling pretty good about 18. And we're managing the decline in the revenues of the special servicing book. We know what we're gonna see, pretty much. There's a lot less vol in the numbers. And so, we have to manage the decline of that business, and we're 100% aware of it, and replacing it with other things, which is why we started our resi business that we've been doing and some other stuff, so.

And the 2.0 delinquency is still very, very small, Jade. That's not gonna be a big revenue driver yet on 2.0s. We'll get those in the next few years, we hope. But I think it's too early to be counting on a loss from 2.0.

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

And then on the non-agency residential mortgage originations, was this quarter sort of a run rate pace, or do you expect that to meaningfully ramp? And did you say that you're gonna do a CLO in the first quarter of those deals, or CMBS?

Jeffrey F. DiModica -- President and Managing Director

No. What I was mentioning in securitization was the residential business, where we built the portfolio of a little over $500 million, so we'll do a non-agency residential securitization in the first quarter to turn that out, take it off of the warehouse line. In terms of the CLO market, which you asked about, on the CRE side, you've seen a lot of deals get done. For people that don't have our cost of capital, the CLO market is absolutely a place to look to that. We finance inside of our competitors. On a swapped basis, our high yield trades in the low LIBOR 200s, and we can't compete with that. In a CLO, that's significantly better than where a lot of our peers are able to borrow in the secured and unsecured markets. So, I think you'll see our peers continue to go there. We have been pushing toward doing some more smaller balance loans, and ultimately, that may be a good exit for that, so you could see us in the CLO market later in '18 or early '19 at some point. But that's not something that we need to lean on because of our capital, both unsecured and secured. So, I think you'll see us stay the course and unencumber assets.

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

Thanks for taking the questions.

Jeffrey F. DiModica -- President and Managing Director

Thanks, Jade.

Operator

Again, ladies and gentlemen, it is star one if you would like to ask a question today. We'll go next to Doug Harter with Credit Suisse.

Doug Harter -- Credit Suisse -- Analyst

Thanks. Can you talk about with where your debt is trading, where it is, what else you can do to the capital structure, or what we should -- what the capital structure might look like a year from now?

Jeffrey F. DiModica -- President and Managing Director

Yeah. And our warehouse lines, in general, are LIBOR 175 to 225, let's just say. And there's a few assets --

Barry S. Sternlicht -- Chairman and Chief Executive Officer

There's not a lot at 175. What would you say the blended spread is on our warehouse lines on drawn capital? Yeah, about 210, 205, 210, somewhere around there.

Jeffrey F. DiModica -- President and Managing Director

So, given that on the warehouse line side, one of the phenomenons we've seen is warehouse lines have come in a lot. Obviously, the banks, from a regulatory capital perspective, like this business. They get cross-lines of multiple assets, and they get a guarantee of some portion of that back from the parent. And these are good lines for the banks. And from a regulatory capital perspective, they are a strong ROE. So, they've pushed the warehouse line business pretty hard, and we're getting better levels today than we got historically. That said, I think that's still a great business for the banks, in that we expect them to continue to bring those levels down. I look at it versus other floating rate assets, like cars and autos. You can see them on the double A-side, and it's still significantly wide at over 200 basis points for crossed with recourse. I think about it first as where I can finance double B CMBS. That's LIBOR flux 160 for this 63 to 63 slice of a capital structure, these borrowings at LIBOR plus 205 or so are significantly better investments for the bank. So, I think the banks will continue to move those threads lower. But A notes haven't really followed.

So, our ability to sell A notes and get them off balance sheet is still there, and we're still doing it on some portion of our portfolio, but not the majority of our portfolio, which is how we started this business. And that is because the banks are really pushing on the warehouse side as opposed to the A note side. So, I don't know that we will replace the entirety of our warehouse lines with unsecured debt, but I think ultimately, as opposed to going to the A note market, you'll more likely see us use unsecured. For the higher-priced lines that we have on warehouse, you'll see us rotate from warehouse into unsecured. I think there's the ability to put $1 billion plus, taking that off accretively or flat. Move them from secured to unsecured borrowing, and the rating agencies will like that. I think you guys should like that, as investors. And that's something that we'll endeavor to do in a short period from now, given how well our bonds are trading.

Doug Harter -- Credit Suisse -- Analyst

Great, thank you.

Operator

Again, ladies and gentlemen, star one if you would like to ask a question today. We'll pause just a moment. We'll go next to Jessica Levi-Ribner with B. Riley FBR.

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

Good morning, guys. Thanks for taking my question. Could you talk maybe a little bit about -- I know you've touched no the non-agency resi that you're doing, but what kind of competition you're seeing there? And maybe if you have market share targets, what you're thinking for that business in the long-term?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

It's really good right now for us. And it's an area that we're kind of -- we have an experienced team, but for me, it's a bit of a learning curve, I have to say. So, I would say we toed in. And the net equity after the securitization'll only be like $150 million probably, or even less, depending on the leverage we want to deploy. We're gonna, like we have done in our loan book, real estate loan book -- we're gonna make -- we could borrow probably $0.87 on the dollar on those loans, but we're not gonna do that. I mean, that would be like a 17, but you'd go -- we'd look like some of our peers and leverage if we did that. What we're probably thinking, it's gonna be 70% or something like that, to create a lower but a really attractive low teens double-digit yield. So, I think we could get to a billion bucks of equity in the business. That would be a target, maybe, 10% of our assets. And hopefully, our assets will be 15%, and it would float up right from there. One of the things that we decided recently as we take our team balance book up a little from here because of the -- we've grown and our asset base is bigger. And the $1 billion was at 10% of assets, and we'd be OK at something a little north of that, so we'll take that business up a little bit and be a little more aggressive in the VPs market. We think actually the VPs as being originated today are pretty high quality.

And to Jade Rahmani's point earlier in the call, I mean, a lot of retail is getting kicked out of these securitizations. And whether they're right or wrong, nobody wants to take the risk, so. So, you're seeing low LTVs but very aggressive pricing and a very bespoke pool of paper being originated. So, we'll go back in that business. And there was a lot of dancing in Miami when we said we were gonna increase our investment in the space. But overall, on the resi side, we don't have a market share target, frankly. It's more emphasizing in our own book and not at 724 -- 742 or 724 -- I'm dyslexic.

Jeffrey F. DiModica -- President and Managing Director

The 724 FICO.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

FICO scores. They're good loans, and we're peeling our way. We're gonna buy an entity into the REIT, and we're gonna grow the origination business ourselves. So, that deal is under contract, and we're gonna -- so, we're gonna take that engine and put it in the REITs. And we're gonna take advantage of the opportunity as long as it meets our ROE targets. And we don't think we're taking too much or any real credit spread risk.

Jeffrey F. DiModica -- President and Managing Director

And we think we've financed ourselves better than anybody in that market. And financing obviously matters. And so, it's an advantage to us, and ultimately, the securitizations business coming back helps a lot. There's a handful of private equity competitors in that space. It's not a massive market today. I think a couple hundred million dollars a month would be an optimistic goal in today's market, absent of owning your own originator. But as a business, we look to grow [inaudible] [00:46:00].

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

Okay, thanks. And then just piggybacking off your comments in terms of VP spying, what kind of yields are you seeing today? And Barry, you said you would be wanting to take it up. Do you have a percentage of equity, like 15%, something like that?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

Something between 10% and 15% is what I'm talking about for the target.

Adam Behlman -- Co-President of Real Estate Investing and Servicing Division

Yeah, spreads as they are in the top of those stack are tightening, so we're seeing 15%-ish yields on the unencumbered, 13%s on the verticals, and probably the high 16%s, low 17%s on the bottom of LVP security, so they're in probably about 50 to 100 basis points, depending upon which of the originators are having the collateral on the deal.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

One thing is, the risk retention rules haven't been one of the things that Trump has deregulated. And there's no sign of him doing that right now. And it has changed the market a lot. The smaller conduits are having trouble competing, and the banks are tough. So, it is a challenging environment today, more so than it's been. But because of the way our business has been structured, the conduit business, they've been able to dance around the changes in the market very adeptly, and I wouldn't expect that would change going forward. So, they're working with these banks, and we can participate in a vertical or we can do our own horizontal. So, mostly, those markets move to vertical deals.

Jeffrey F. DiModica -- President and Managing Director

It's Jeff. I would also say that deals today have a much lower LVP than certainly pre-crisis or than 2.0. And as LVPs have come down into the high 50s and low 60s, you've seen a much better collateral, which leads to, as Adam gives you, numbers of 15, the spread between a pre-loss and a post-loss expectation in yield is tighter today than it's ever been historically. You have more investment grade loans, so you expect to lose less growth by getting to kick 25% plus out of these deals still. So, we shaping the pool in the way that we want to. Our post-loss is not far from what it's always been, even though pre-loss yields have tightened in because we've moved to this higher investment grade collateral with a significantly lower LPV.

And the CMBS market, that market's responding to it. Triple As aren't trading mid-70s for no reason. They see that as better collateral. And it's a bank-dominated collateral, investment grade-dominated collateral, and it's trading very well. And bond buyers see that as well.

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

Okay, great. That's really helpful color. One last question from me would be just, I know that you've had kind of a long-standing frustration with how the stock trades on a dividend yield basis. What do you think kind of the equity markets don't get that the debt markets do? Do you think maybe the property portfolio's lost in translation? Is it the conduit? How do you guys think about that?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

I'm sorry, can you say that again? What was your question?

Jeffrey F. DiModica -- President and Managing Director

The dichotomy between the debt markets and the equity markets. What are the equity markets missing?

Barry S. Sternlicht -- Chairman and Chief Executive Officer

So, we're an ETF, and as the most liquid name in our sector, we kind of -- in our mortgage or yield ETF, we're one of the largest players now. We're number three. So, we get whip shot a lot with people's expectation where rates are going, and when the resi REITs, which don't have positive convexity, the rising interest rates get crushed, we get sold off with them, and it's a blind trade. It's just programmatic. It has nothing to do with our underlying assets. It was amusing, as people thought rates were going up -- well, sort of amusing -- that we were going down with the residential rates. And most of our peer's earnings go up, not down with rising rates. ETFs don't care. We're all in the same bucket, and they just sell us based on our market caps. That's one issue.

I'd say the second issue is people are worried about the servicer that must be in our yield, that is, the declining asset base. And we're well aware of it. It's not a secret that the ROE from that business will go away over time and be slightly reduced. And maybe that explains it. But you can't account for the differential between us and our nearest competitor. Even if a servicer had zero and we adjusted our dividend to that level, we trade what our peers trade. So, they trade at like 7.9 or something like that, and they trade at 8.9. So, take out the earnings and you get the same dividend yield as they do. But we have all these equity assets. I mean, we have a totally different book. I mean, we have appreciating equity assets. We don't have loans paying off at par. We have actually assets that are rising in value on the whole fairly significantly, producing double-digit cash yields every day.

I mean, we were talking about it the other day. There are things we can do with our equity, but just as we spun out our single-family Starwood rate point. I mean, there's ways to recognize value if we have to down the road. We're doing this because we want to stretch the duration of the book. So, the debt markets really value with the diversity of our income streams. And they value the quality of -- they're looking at the LTVs. They're looking at the scale of the enterprise, the size of the company, and our ability to sort of produce earnings from multiple cylinders. We never said that every cylinder was gonna be operating, firing at the same time. And that's why you have 12 different businesses. You may recall, we were out of the conduit business, almost shut in the first quarter of this year, I think it was. And we did nothing. And then the team said to me, do you want to make it up the rest of the year, the earnings that we had in our budget? And I said, you just do it at the right pace. Do it at whatever pace you're comfortable with, but don't press it. Don't force it.

So, we know that these businesses all won't work perfectly every moment. But the credit markets love that. Somehow, that hasn't translated into a sick dividend yield for the stock. And it's kind of odd. I mean, you don't really see this very often in the capital market. Usually, it's the opposite. The debt markets are freaking out, and the equity markets think there's nothing going on, and they're just fine. So, you see the opposite here. You see the credit markets loving the story, loving the diversity of the asset base, enjoying the equity, the stability of multis and fully leased office buildings, and the equity markets don't seem to care. So, I don't know. Maybe Zach needs to get better at what he does. He's sitting in front of me smiling as I say that.

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

I just got him in trouble. Okay.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

I don't know. I don't know. I mean, that's just nine years, and the company's bigger, better, more diversified, and we continue to -- it has to be the income from the servicer. I almost want it to go away, just sell it, and just move on and stabilize the company because we even considered that. But we love the business. It gives us optionality. It gives us deal flow. And we thought rates would rise rapidly and we'd have more bad loans to service, so. It hasn't quite. That didn't happen, but we're fine. So, the 10-X investment turned out to be something nobody obviously valued, and we made, I guess, again, close to $100 million in proceeds. $60, $70 million in proceeds in cash for the company. So, we're -- it's a long road. We're OK.

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

All right, well, thanks for that.

Operator

Ladies and gentlemen, that will conclude our question and answer session. I'll turn the call back to Barry Sternlicht for closing remarks.

Barry S. Sternlicht -- Chairman and Chief Executive Officer

Well, everyone, thank you for dialing in and listening to our story. And the team's around to answer any questions. And as you know, our transparency and our desire to partner with you has been the way we've started this company from the beginning, no surprises. And we're delighted with the team's performance, and look forward to another great quarter. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may now disconnect.

Duration: 55 minutes

Call participants:

Zach Tanenbaum -- Director of Investor Relations

Rina Paniry -- Chief Financial Officer

Jeffrey F. DiModica -- President and Managing Director

Barry S. Sternlicht -- Chairman and Chief Executive Officer

Adam Behlman -- Co-President of Real Estate Investing and Servicing Division

Jade Rahmani -- Keefe, Bruyette & Woods -- Analyst

Doug Harter -- Credit Suisse -- Analyst

Jessica Levi-Ribner -- B. Riley FBR -- Analyst

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