STWD - Starwood Property Trust: The Dividend Will Stay Rigid In 2024

2023-12-10 08:02:01 ET

Summary

• Starwood Property Trust has maintained its quarterly cash dividend distribution at $0.48 for almost a decade, even during periods of material economic disruption.
• The mREIT has built an incredibly diversified portfolio that includes commercial mortgage loans, properties, infrastructure, and residential debt.
• Bears have raised concerns about the 14% exposure to office properties and the potential impact of working-from-home trends and higher interest rates on the dividend.

Starwood Property Trust ( STWD ) has kept its quarterly cash dividend distribution at $0.48 per share for nearly a decade. The rigid predictability of the distribution is intense. It's been maintained through the ZIRP era, the pandemic, and the Fed's current battle with inflation. The $6.3 billion mortgage REIT focuses on the origination and management of commercial mortgage loans and other CRE debt investments but also owns properties, infrastructure debt, and residential debt. Total assets stood at $27.3 billion at the end of its fiscal 2023 third quarter, down sequentially by $700 million. Unlike large mREITs like Annaly Capital Management ( NLY ) that focus solely on specific sectors, STWD has used diversification as a moat.

STWD is currently swapping hands for 10.3x its annualized distributable earnings. This was $0.49 per share at the end of the third quarter, unchanged sequentially but down 2 cents from $0.51 per share its year-ago comp. Critically, bears flag the 14% exposure to office properties as a core risk against wider working-from-home trends and interest rates remaining higher for longer as reasons why the dividend might be cut next year. The current 102% dividend coverage, roughly a 98% payout ratio, is admittedly clutch. Still, STWD's comparatively low GAAP debt-to-equity ratio has provided a moat for the REIT to weather the economic quagmire in 2024.

STWD's 1.47x debt-to-equity ratio has been falling and currently sits lower than its most comparable peers and is 66% lower than the most highly leveraged commercial mREIT Blackstone Mortgage Trust ( BXMT ). It's important to note that the mREIT's non-GAAP adjusted debt-to-equity ratio is higher at 2.42x . This is a key consideration against broad expectations that 2024 will see the Fed forced to cut rates in the first half of the year on the back of the US tilting into a recession. The Chicago Mercantile Exchange's 30-Day Fed Funds futures pricing data is currently pricing in a 42.5% probability that interest rates have been cut by at least 50 basis points by the 12 June 2024 meeting.

Commercial Lending Credit Underwriting Quality, Net Asset Value, And Dividend Safety

The commercial lending segment held 156 loans with a weighted average risk rating of 2.9 which was unchanged from the prior quarter. Around 58.86% of loans rated 3. This describes loans performing in line with underwritten expectations, with a loan to value that does not exceed 80% and with stable occupancy. There were 4 loans rated 5 which formed 3.16% of the commercial lending portfolio. The specter of a recession next year is the core uncertainty facing mREITs but STWD has been actively deploying capital with $2.7 billion of new investments over the twelve months from the end of the third quarter.

Commercial term loans originated in 2023 as of the end of the third quarter, excluding loans held for sale, stood at $420.65 million . This was down from $4 billion in the year-ago comp. This drop has been countered by a ramp of infrastructure lending originated in 2023 which came in at $554 million as of the end of the third quarter, up from $123 million in the year-ago quarter. There is still uncertainty around whether the US will fall into a recession with November non-farm payrolls rising by 199,000 and beating consensus estimates. Unemployment also fell to 3.7%. The Goldilocks scenario of interest rate cuts next year wrapped around continued economic strength is now highly probable and is my base economic case for next year.

STWD recorded third-quarter revenue of $521.55 million, up 33.5% over its year-ago comp but a small miss of roughly $3 million on consensus estimates. The mREIT originated or acquired $652 million of assets across its segments during the third quarter with $444 million in infrastructure lending forming 68% of the total and $116 million of conduit loans forming 17.8%. Critically, STWD received repayments of $1.1 billion across its segments, up $345 million sequentially. The ramp in revenue combined with originations that have stayed strong, albeit down from prior years should support dividend coverage next year.

The mREIT also recorded a GAAP book value per share that ended the quarter at $20.18, down roughly 33 cents sequentially. The non-GAAP undepreciated book value was higher at $21.15 per share, down sequentially from $21.46 per share. Hence, with STWD currently swapping hands for $20.17 per share, it is trading at a discount to both GAAP and undepreciated book value per share. I'm comfortable with the dividend safety on the back of continued US economic strength. The common shares are a hold at this level.

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