Starwood Property Trust, Inc. (STWD) Earnings Call Transcript

Greetings. Welcome to Starwood Property Trust Third Quarter 2026 Earnings Call. [Operator Instructions] Please note this conference is being recorded. At this time, I'll now turn the conference over to Zach Tanenbaum, Director of Investor Relations. Thank you. You may now begin.

Thank you, operator. Good morning, and welcome to Starwood Property Trust Earnings Call. This morning, we filed our 10-Q and issued a press release with a presentation of our results, which are both available on our website and have been filed with the SEC. Before the call begins, I'd like to remind everyone as certain statements made in the course of this call are forward-looking statements, which do not guarantee future events or performance. Please refer to our 10-Q and press release for cautionary factors related to these statements. Additionally, certain non-GAAP financial measures will be discussed on this call. A reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP, please refer to our press release this morning. Joining me on the call today are Barry Sternlicht, the company's Chairman and Chief Executive Officer; Jeff DiModica, the company's President; and Rina Paniry, the company's Chief Financial Officer. With that, I'm now going to turn the call over to Rina.

Thank you, Zach, and good morning, everyone. DE was $0.31 per share in the quarter or $0.41, excluding realized gains and losses from commercial lending resolution. In order to provide a comparable metric to commercial mortgage REIT and additional perspective on assessing the run rate earnings of our portfolio, we have added this new measure of distributable earnings through our press release supplement and 10-Q this quarter. I will begin today with this quarter's progress towards resolving nonaccrual loans and REO and the changes in our reserves and book value before turning to our individual businesses. During the quarter, we resolved $254 million of nonaccrual and REO, including the sale of 2 multifamily REO assets with an aggregate DE basis of $134 million or $97 million and 2 units in our New York City residential project for an additional $12 million. All sales were in cash with no seller financing. We also returned the final $108 million portion of our formerly 4-rated Brooklyn office loan to accrual after securing a lease with a credit tenant and bringing the underlying office property to 100% occupancy. In commercial lending, we have $1 billion of reserves against our nonaccrual and REO assets after recording an increase of $369 million in the quarter due to third-party model macroeconomic conditions, which [indiscernible] as a result of the rise in interest rates. That consists of $822 million of CECL and $217 million of REO reserves, which translate to $2.85 per share that is already reflected in today's undepreciated book value of $17.22. This book value also reflects a $0.24 reduction in the quarter resulting from the effect of higher interest rates on the fair value of the fixed to floating rate swaps on our corporate debt. To the extent that debt finance is floating rate assets, we swap that debt to a floating rate. Over time, higher interest income on floating rate assets supporting this corporate debt are expected to offset this book value reduction. In commercial lending, we originated $2.4 billion of investments in the quarter, of which $1.5 billion was funded. We also funded $236 million of pre-existing loan commitments. Net of $1.2 billion of repayments, the portfolio increased by $528 million to a record $17.8 billion. Turning to residential lending. Our on-balance sheet loan portfolio ended the quarter at $2.2 billion, and our retained RMBS portfolio was $310 million. We recognized a $39 million negative mark-to-market on loans net of related hedges, primarily due to spread widening. On a year-to-date basis, the net mark-to-market was just $5 million, evidencing the effectiveness of our head strategy. In addition, we improved financing costs on $356 million of financing lines in the quarter, reducing spreads by a weighted average 24 basis points. I will now turn to our Property segment. Starting with Woodstar, our 15,000-unit affordable multifamily portfolio in Florida. We implemented the authorized HUD rent increases effective July 1, averaging 8.9%, which increased earnings in the quarter by $1.7 million. In September, we refinanced $415 million of debt in this portfolio, $35 million of which closed in the quarter and the remainder in October. Given appreciation and NOI growth, we were able to upsize $146 million at SOFR plus 165, our $160 million share of which can be reinvested to increase future earnings. Since acquisition, this portfolio has returned the entirety of its original cost basis plus an incremental $275 million through cash-out refinancing, providing an infinite return on our original capital. In net lease, we acquired $32 million of properties at a blended cap rate of 7.37%, bringing purchases since acquiring the platform of $556 million at a 7.45% cap rate. The portfolio now stands at $2.8 billion comprising 534 properties across 44 states, a weighted average remaining lease term of 16.6 years, average annual rent escalations of 2.3% and 100% occupancy with 0 faults. Annualized base rent increased $193 million from $187 million last quarter as certain construction assets were brought online. During the quarter, we reduced some of the platform's overhead, helping the business become accretive to DE per share. Next, I will turn to our Investing and Servicing segment. In our special servicer, L&R, we continue to benefit from elevated resolution volumes, which drove $37 million of special servicing fees in the quarter. Our active servicing portfolio ended the quarter at $10.2 billion, and our named servicing portfolio was $90.8 billion. During the quarter, Fitch reaffirmed LNR CSF1 special servicer rating, the highest rating available. LNR remains the only special servicer to hold this distinction. And finally, our conduit, Starwood Mortgage Capital, securitized $210 million of loans at profit margins in line with historic levels. Concluding my business segment discussion this morning is our Infrastructure Lending segment. We committed $505 million, while repayments totaled $389 million with the portfolio ending the quarter at $3.1 billion. Credit in this portfolio remains strong with 100% of its loans rated 3 or better. Turning to liquidity and capitalization. Our current liquidity stands at $1.1 billion. This does not include liquidity that could be generated from expected proceeds from REO sales, sales of assets in our Property segment, cash out refinancing direct leveraging or excess capacity to raise incremental corporate debt. We continue to operate a conservative leverage levels, ending the quarter at a debt to undepreciated equity ratio of 3.1x. Our unencumbered asset pool stands at $7.2 billion against $4.5 billion of unsecured debt, a coverage ratio of 1.6x at quarter end, again, well in excess of our 1.2x covenant. With that, I will now turn the call over to Jeff.

Thanks, Rina, and good morning, everyone. I want to start with the progress we are making in resolving legacy assets and reducing our exposure to loans originated in the pre 2023 rate environment. As Rina said, we completed over $250 million of resolutions in the quarter and remain on track to achieve the over $800 million resolution target for 2026 we outlined previously which would be more than 40% of our nonaccrual nREO. We had no new nonaccrual loans and no new foreclosures again this quarter. Beyond resolving legacy assets, our other 2 priorities remain putting capital to work and attractive new investments and optimizing our capital structure. We made progress on all this quarter. We invested $3.2 billion across the platform, including $2.4 billion in commercial lending, bringing year-to-date investments to $8.2 billion and total undepreciated assets to a record $32.3 billion. We also made progress on the right side of our balance sheet. In July, we repaid the $500 million of corporate debt 6 months before maturity at its first PAR call date. That debt cost of SOFR plus 295 basis points compared with an average equivalent spread of approximately SOFR plus 203 basis points on the $2.1 billion of corporate debt we issued or repriced this year, a reduction of approximately 92 basis points. These transactions lowered our funding spreads while extending our corporate debt maturities. We also redeemed 2 CLOs during the quarter in commercial lending. Having access to multiple financing channels allows us to move assets between funding sources and optimize our borrowing costs. Today, we have $1.1 billion of liquidity. Our unique access to liquidity supports our consistent and selective investment activity and our ability to manage pre-2023 assets originated at lower interest rates toward their best economic outcome, not the one that creates short-term liquidity at the expense of long-term shareholder value. Our liquidity also allows us to act on our conviction in the value of the company. In the quarter, we repurchased $108 million of common stock, bringing year-to-date repurchases to $138 million. We will continue to weigh repurchases against new investments and other uses of capital with the same focus on long-term shareholder returns. We received $1.2 billion of loan repayments during the quarter and an additional $320 million after quarter end, bringing year-to-date repayments to approximately $2.8 billion. More than 2/3 of our repayments came from loans originated before 2023. These borrowers were most affected by the rate rise, but continue to execute their business plans and refinance, even in office, where we had a significant paydown on one of our higher risk rated loans. In that case, the borrower sold one of the buildings at a price per square foot materially above our existing loan basis, meaningfully reducing our exposure on the remaining collateral. Our internal underwriting driven by our in-house asset management team has projected elevated quarterly repayments in line with the $1.2 billion we saw this quarter to continue for the foreseeable future. Combined with our continued and significant investment activity, these repayments should materially reduce the percentage of our portfolio originated in the prior rate environment, which stands at $8.5 billion today. representing 40% of our loan portfolio or 20% of our total assets, among the lowest in our peer group. This percentage will continue to fall as loans are repaid or resolved and as we continue to invest in new loans as we have consistently done. Of that $8.5 billion, $3.8 billion are rated 4 or 5 today, and $4.7 billion are rated 1 to 3 with average debt yield of 6.2% in multifamily, 9.3% in hospitality and 8.9% in office. These healthy debt yields help explain the repayment activity we continue to see from loans originated before 2023. Next, I will address a CECL reserve. The 10-year treasury rose 80 basis points during the quarter and forward SOFR increased by 100 basis points. As we have discussed before, we use a third-party model-based methodology that incorporates forward-looking interest rates and economic assumptions. The bulk of this quarter's reserve increase was driven by that increase in interest rates. Higher projected interest rates increased borrowers' expected debt service and can reduce the proceeds available to refinance their loans even where property level operations continued to improve. Our CECL model produced significantly higher reserves on more rate-sensitive assets, including multifamily loans originated before 2023. Our total CECL reserves increased approximately $337 million this quarter to $822 million and owned real estate reserves increased $32 million to $217 million. Substantially all of the increase was in our general reserve. Our 4-rated loan balance increased $290 million in the quarter, and our 5 rated loan balance increased by $440 million. All of this quarter's downgrades were on loans originated before 2023 and more than half were on multifamily assets. Given their consistent performance in rent growth, investors buy multifamily assets at lower cap rates than other CRE assets. This makes them the most interest rate-sensitive assets in our lending portfolio. Since quarter end, rates and forward SOFR have declined, which is a positive development for these borrowers and their ability to refinance. In addition, the majority of our multifamily loans are rated 1 through 3 and carry a healthy 7% debt yield which are refinanceable in today's higher rate environment. We believe the impact of higher rates and the challenges in our portfolio are substantially reflected in our book value. Moving on to our asset resolution process. our approach remains consistent. We evaluate the proceeds available today against the time and capital required to achieve a better outcome where a sale makes sense, we sell. We're operating the asset, improving performance taking on deferred maintenance and completing the business plan produces a better expected recovery. We have the people, resources and liquidity to do that. Our 300-plus person company, combined with our manager, Starwood Capital gives us access to operating expertise and property level information across sectors and markets, and we bring that experience directly to our assets. The objective is to maximize recovery and recycle capital into investments that contribute to future earnings. A good example of the value of hands-on management and patients in resolving legacy loans is the $300 million loan we originated in 2021 on a 600,000 square foot office project in Brooklyn, New York. With the execution of the third and final lease the building is now fully occupied. And as Rina said, we moved that piece to accrual in the quarter as a result. With the sponsor unwilling to contribute additional equity we restructured the loan to support continued leasing in lieu of pursuing foreclosure. Over the last 2 years, our close collaboration with the sponsor helped drive occupancy to 100% and with 3 accretive long-term leases, materially improving the loans risk profile and positioning the asset for sale or refinancing. I will note that sponsors have contributed $710 million of additional equity since closing to our 4 and 5 rated loans, including $128 million on loans downgraded this quarter. These contributions demonstrate borrowers continued faith in their investments as they contribute capital to exceed their business plan. I want to conclude my remarks today with a discussion on the valuation of our stock price and what one could infer the market is implying. CRE loans represent roughly half of our assets. The other half includes infrastructure lending, residential lending, our equity portfolio and our investing and servicing business. Some of these businesses have countercyclical earnings drivers, different financing sources and different opportunities to create value. These assets continue to perform well. especially our energy infrastructure business, which benefits from long-term increased demand, our net lease business, which provides a long-term contractual rental income and significant annual rent increases and our special servicer, LNR with over $90 billion of main servicing and a significant pipeline of revenue opportunities. We spent years diversifying and building those differentiated businesses, which have dampened earnings volatility versus our peer group through this historic rate rise. And in this quarter, which saw the largest quarterly rate increase we have seen in the century. These businesses allow us to allocate capital to the opportunities we find most attractive as markets evolve. Today, our undepreciated book value stands at $17.22 per share. Today's share price implies a discount to that book value of $1.6 billion beyond the $1 billion of CECL and REO reductions already on our balance sheet. If you attribute that entire discount to our $4.5 billion of 4 and 5 rated loans and REO, the market is implying a loss of 58% on those predominantly first mortgage assets which were all originated before 2023. Recovering only $0.42 on the dollar on loans originated at 65% LTV would imply collateral worth roughly 27% of its original underwritten value. In other words, today's stock price is implying a 73% decline in collateral values across that entire pool. For perspective, our owned real estate resolutions in the quarter were sold at 72% of our original basis, and our owned real estate sales currently under contract are at 71% of original basis, both well above the 42% implied recovery in our stock price. An ultimate valuation approach is a sum of the parts analysis. If you were to value the businesses outside commercial real estate lending using public market yields, today's stock price implies an approximately 20% yield on our CRE loan book, which is well above monoline commercial mortgage REITs. We believe the market is assigning too little value to the earnings and diversification provided by the other parts of our company. To conclude, we continue on our stated path of increasing our balance sheet with accretive new investments while strategically decreasing our exposure to loans originated prior to 2023. We are on track with our 2026 resolution target. We expect repayments to remain robust and we continue to put capital to work in new investments. Our diversified businesses provide earnings and flexibility as we execute that plan. With that, I'll turn the call over to Barry.

Morning, everyone. Thank you, Zach, Rina and Jeff. What an interesting time to do a call like this. every 30 days, it seems like you have a totally different picture that you're facing. I mean, 30 days ago, the tenure was approaching 5:30 and today, it's 4.87. And remember where it was at the end of the quarter [indiscernible] I want to step back a little bit and talk about real estate asset class as a whole because with all the chaos there in the interest rate markets and the volatility and political [indiscernible] politics, real estate is healing. Underlying asset classes are getting better and better at an increasingly better pace just yesterday, CoStar raised the rent growth [indiscernible] actually have office rents going up almost 3%, 3.5%. You also have industrial rents rising 2% and the actual print for the quarter was 3.5%. So because of the reduction in supply, which is only going to fall further because of the rise in interest rates and rising construction costs and some of the inflation in construction has come from the heretofore, the data center stealing all the construction workers and paying them 2 to 3 times what they were making building commercial office buildings. So for the first time in the history, we had more data centers being built than all the other asset classes in real estate, particularly in the office market. I think you have to look at that as the foundation of our book. We're at $32.3 billion enterprise. Our nearest largest competitor in $17 billion, we're more than twice the size by equity, more than 2.5 scale. And you look at what's happened to us, if you take the longer view, several of our competitors have actually left the playing fields. Apollo just is liquidating its commercial mortgage REIT with a dividend and the sale of few remaining assets. There are several others that are studying their future, they're subscale and they don't have the diversification that we have. And so at least in the public sector, we are still one of the biggest gorillas when we have adequate liquidity and an incredible mix of array of businesses that will power us through this turbulence, which I think might be the best way you can describe it. But the impact, again, of higher rates, the beneficial impact is less supply unless supply means better outcomes, we think, for rents rising across the landscape of our asset base. It's also true in asset categories like senior housing, which have less than 1% [indiscernible] student housing and hotels where you see pretty robust numbers coming out of the higher-end assets, especially luxury and a turnaround now at the bottom end of -- which is slow, but we haven't seen a positive move in the lower end of the market for several years, construction jobs increase, [indiscernible] increase, manufacturing jobs, extended stay hotels begin to get pricing power again. And again, supply being hit, this should get better and better. So in the meantime, you have to deal with what we're dealing with today, which is higher rates and much more importantly, a very much higher forward curve. And I continue to say, and I said it on CNBC the other day that I do think [ Kevin Worse ], and most of the people talking on TV are knuckle heads. In the sense that rates are not working on this economy, maybe they worked on a different complexion of the economy. They don't work on this economy. What is actually going to slow the economy is the credit crisis in data centers. When corresponds are trading at 15%, you can't build data centers. And the Neo cloud faced some serious issues as does Oracle, look at their credit default swap spreads. And the markets are breaking themselves, and it has nothing to do with [indiscernible] quarter point or next December, another quarter increase. Also raising it isn't opening the Strait of Hormuz. It's not going to make foreign buyers jump for joy and buy our debt. We've pissed off most of the world. this economy created 5 million jobs since the Fed raised rates 500 basis points in the 3 sectors of the economy that are growing the economy there, which are health care, education and government. And in fact, manufacturing, which is impacted by higher rates, no doubt, you won't buy your refrigerator, if we can make them here any more washers and dryers. I mean that part of the economy is 12 million of 160 million jobs, whereas the health care, government education is nearly 50 million jobs, and they're not impacted. In fact, those industries added jobs in the GFC. So you can't use this, but you do create a victim, which is a federal government, which has to pay ever higher interest expense on an ever-increasing deficit. And it does for the housing market, and it has hurt real estate. Obviously, higher rates have made our borrowers think they cannot refinance and get us out even on our loans across not just us, across the whole country. You've seen a dozen BDCs lower dividends. You've seen every mortgage rate to date other than us lower their dividends. because they're all nervous about their borrower's ability to refinance us. And you have to question the V in an LTV in this rising interest rate environment. So again, I think my guess is if we continue to see the weakness given the Democrats very impressive performance in the election, that you will see -- we already saw the [indiscernible] and the market hadn't really corrected for it. But now it will be harder to take longer to get data centers completed. They'll be more expensive to build. They've already changed dramatically the return on investment as you have to provide power on your own or you have to provide LCs for the power that you're taking through a take-or-pay contract. So only the big boys can play. Supply was going to come down anyway. But it won't happen immediately because there's stuff being built today. you'll see it in the markets anticipating with the chip stocks, the future of the economy slowing GDP coming down. If that happens, rates come down. So -- and I think that's going to be a very sunny day for us in the real estate property sector. because I think rates will come down with a slowing economy. And again, it didn't happen because worst raise rates a quarter pointed happened because the credit markets couldn't handle the scale of the spending and start to differentiate in question of the credit quality. And probably the most important event of the fourth quarter will be the Anthropic IPO coming in a few weeks. That will stabilize or destabilize I think some of the say spending half of the backlog of Oracle is to open nearly $350 billion. And as goes them, we'll go probably the expansion of the data centers for a while. But this technology is real. It will change the world. And it's just a hiccup. I mean, I think you started the auto industry with like or 90 part companies, you went up with half a dozen and then 3. So you're seeing the same thing in this business. You will have survivors, big balance sheets, good capital. And it will happen, and it's critically important, we put the infrastructure in place. to compete with foreign capital. If we don't, many of these data centers will go offshore and they won't go to any time soon, by the way, but they'll go offshore, they'll go to Europe where you have power or China, unfortunately, or Australia and Japan. We actually are active in all these markets. So we can tell you that demand is shifting already as they don't have the opposition that you've seen in the United States rise up, and nobody really can tell you why it happened, but it did happen very quickly. So right now, I'd say, -- but I think one of the things you saw and we don't know about is what will happen to the job markets. And I think nobody the jury is out. Will people be able to hold their jobs as AI spreads. I think what you saw America was saying, let's slow down AI because I'm going to lose my job and only the wealthy will benefit from this AI boom. They don't own interest in open AI, anthroopic and data centers. And I think at times like this, you see a significant price discovery taking place right now, I mean, we're going to sell stuff when we're on the equity side, obviously. We've seen some of our multi sales hold their bids, and we ourselves are bidding on industrial in Europe and repriced the deal down 10% to 15% because with higher rates to get the same IRR, you have to lower the price. Some buyers are saying, okay, some buyers are saying, "I'll just wait and wait for a rainy day. Even the German [indiscernible] has dropped 30 to 40 basis points now. So global rates are shifting down. And I think the market is also anticipating that rates are mostly a function of inflation. And I guess the strength of the icebending, but inflation has been driven almost entirely in Europe by energy prices. And so if there is a resolution to the Iran situation, whatever that might be, and oil flows, I think most people expect oil to drop quickly even though you read about some of the disruptions in production I do think you'll see and that you can see it every time there's a hint of a resolution, you see -- and with oil prices coming down, inflation comes down, I'm sorry, pieces of inflation impacted by oil prices come down. Rates come down the forward curve shifts, and we're going to be smiling. But right now, with price discovery and clear and rates are much higher in the short end and the curve shifted higher and many borrowers are definitely burning. And what you have is 2 things that happen. One, they stop investing in their assets because they feel like they're just putting money into the debt. So if it's a multi, maybe they don't turn the unit. And if it's -- or they don't do the pool repairs, they don't fix the broking equipment in the gym. And if it's an office building, they don't have the TI, they don't put the money for the TI to bring the tenant to build because you're just putting in TI for the borrower's case. Starwood is uniquely positioned really to handle all this stuff. I mean we are in the midst of converting an office building. We took back a very large public company gave us the building back after losing $150 million and were converted to get into a residential project, and we're on our way. And we expect to make money on and after how we sold, we would have lost probably close to $100 million because somebody else would have to do the work. We can do that work and we can take over multi and we can finish the pool, get the pool furniture. And then we'll sell it, and we've done it successfully now for years and it's actually our core business is REO. And I think when you look at our company, you have to really look at the nature of what we do. I mean, we have $3 billion of assets that we purposely bought including our significant multifamily portfolio we call Woodstar, which Rina told you, we have $1.5 billion gain, and we have no money in the deal. We've also expanded the cap rate on that portfolio from 4.2 to 5.2. And it's been able to hold and keep its value gains because of the dramatic increases in rents. And don't forget, we have no real estate taxes in that portfolio. So that's not going to happen. You pay no real estate taxes in affordable. So it's just expenses and earnings growth. And expenses are not real estate taxes, which is an area that has been a bit of a black eye for a lot of real estate notes municipalities try to balance their budgets, increasing real estate taxes. So real estate actually does turn into a safe haven in volatile times, and it wasn't very exciting. Real estate is boring. And when your tech stocks and your chip stocks are rising 50 points a day. We're kind of a boring sector of the market, but we are a reliable place to convert ordinary income and capital gains, and we expect investors in every -- like fifth or sixth crisis. I mean, usually, you always get capital flows back into the real estate market. You can see that because our parent company just raised a $10 billion fund. We didn't think we'd reach that. But we were able to get there because investors said, "Hey, this is a good time to invest in equity real estate." And that's actually good because there's capital to clear the market and we're in sort of -- again, the LaPCARis on track at Daytona and we're waiting for the race to go again. But there is capital, there is dry powder, and there is interest in this asset class globally because the fundamentals underlying the asset class almost all over the world are actually getting better. So I'll say 1 last thing. I selling assets in this environment because the bid-out spread takes longer. And again, we're not distressed when we have plenty of liquidity. We've got great earnings power. We have a lot of other businesses doing fine, highlight again our energy infrastructure business, which is a powerhouse business for us and as I think our loss ratio is 99%, 99.6% performing and it's really an incredible asset to our firm and provide solid footing for us going forward in an area we continue to work to expand. It's been so good that it's actually repay faster than we wanted. And even today, you saw repayments in the quarter. There is liquidity. I should have mentioned that spreads and real estate really haven't blown out very much. But we have competition when AAA for the hyperscalers are trading 30, 40, 50 basis points wide. You have competition for capital, but real estate in the credit markets is reflecting the quality of the asset base today.

Lending spreads throughout are tight at the time of the year right now.

The lending spreads are at the time of the year. I didn't know that, but I know they were tight. So I think the credit markets are always sort of ahead of the equity markets and the equity markets are nervous, but our ability to refinance our debt and drive enterprise forward is great. But we have to be realistic. I mean we're probably not going to be able to resolve some of our assets as fast as we hope. We expect to hit the $850-ish million that we told you about for the year. We will -- most of it is already completed or about to close. So that will happen. But we may get other assets that we can't -- we have to deal with and we'll manage those as we go forward. So given all these uncertainties, I think we will have to examine what we're going to do with our dividend which has been paid well above the DE rates, the earnings rates we've been producing in the last couple of quarters. I did think as we looked out, we could see what we expected to be the resolution of our asset base, and we were fairly confident we'd be able to restore earnings power, but I think there is a question of prudency. Should we reduce the dividend and then have increased it as we get the earnings power off of these underperforming legacy asset base that Jeff talked about. Most of this is from the assets we had, almost all of it is from assets we had pre the rate rise. But it's only 20% of our total asset base today. And obviously, all of it is not impaired. So we will have a meeting with our Board and discuss this and figure out a rate that we think is I think the market obviously is expecting it. Look, our stock is trading it. But I don't think the market appreciates again, the diversity of our enterprise. And nobody's -- everyone's fired up. I mean there will be a great opportunity for going forward to continue to extend our business, grow our business. And I do think as we resolve some of these loans, we will definitely have the ability to restore our earnings power and the dividend again. So I'm not sure many of our peers will be able to do that. And so anyway, I think that's -- and we also can use our depreciation field, which allows us to actually have a lower payout ratio. And then again, our goal is long term, we're all major shareholders of our own company. I have to say I've never sold a share. So it hurts me to do anything to the dividend. But I think the right thing to do is navigate through this valley. And I think you're going to see some pretty good sunshine ahead for us. And so with that, we'll take questions.

[Operator Instructions] Our first question is from the line of Don Fandetti with Wells Fargo.

You talk a little bit more about kind of your thinking in the reserve and provision. I'm just trying to get a sense, obviously, the Fed could raise again maybe another 1 or 2 times, like what's sort of built in there? And do you feel like you kind of lean in here to Kitchen sync? Or is this the type of thing that we will just kind of see like a couple of quarters of higher provision kind of like we've seen in the past with time and other periods of time?

Thanks, John. As you know, our CECl was kind of allocated to our 4s and 5s. But in terms of where rates are going, our CECL is also run against forward interest rates. So with Fed funds expected to go from 3.75%. On March 1, we put some perspective on March 1 of this year, the first day of the war forward SOFR for the end of 2027 was supposed to go to 2.9% -- with [indiscernible] 2.8%. As of middle of September, it was up to 5%. But right now, today, it's saying it will be around 4.45 or 4.50 up from 3.75. Fed is pricing in the curve is pricing in more rate hikes. But our CECL model with the reserves we have today are already using that because we use forward SOFR and the CECL model, as we told you, is 90-plus percent allocated towards our fourth and fives s, where we think the most difficult assets will come. And as I said in the prepared remarks...

[indiscernible] you can hear me, really trouble with mic. After an internal allocation in our mind. Not a specific reserve, but we look at those and say, okay, that covers that. And just for the benefit of all of you, which you know that also in the main case, there's people with less sophistication on the phone. We don't control the CECL reserve. It's in the [indiscernible]. And we put it into a machine and it pops out were reserves. So it is what it is. And we take what it has, and that's what happened to us this quarter, and that's what you saw it [indiscernible].

So I think that Barry [indiscernible] one thing is where we serve go from here, and we can't tell you because if we look back last quarter, we wouldn't have expected this level of reserve build, but then we have the trade move. And so we're going to take a look as we go. We have a very healthy debt yield, as I said, on our 1 through 3 rated, the ones that don't have the bulk of that allocated sort of reserve. We have very healthy debt yields on them, as we said. So hopefully rates stabilize and we can get to the top here.

Got it. And on the multifamily, I mean, Barry's comments about supply going down with the rate rise is a good point. Are you still feeling like when you take these multifamily assets back that you can sort of value is protected and ultimately come out of the other side given or higher.

Yes. I mean, the chips -- we have 374 million shares outstanding or something like that. So you're talking small losses, if there are losses at all. It's $10 million here, $8 million here, $3 million there. It's not really not material in the scheme of things because we are so big. That's one of the reasons I said you have to keep in mind how big we are. When Rina talks about $400 million or $300 million or Jeff talks about that. We're a $32.3 billion balance sheet. We're not $1 billion, $2 billion balance sheet. We got a big balance sheet. So the reason I mentioned it. And not really I'm not really worried about our multi book, and I actually -- there's -- we will make more money likely if we're -- it really depends on where the asset is. But I can tell you because we just agreed to sell half a dozen multis in our equity book. I was expecting price cuts and some have sold it a 5.3 or 5.5. One is below a 5. People are buying the future now. And it's a good asset in a good market. If it's really crappy stuff, you're talking 7s. So it really goes to the quality of what you lent against also, which you guys can't see. So -- but overall, I'm not really worried. We'll have defaults in our multi book because that's where they just don't have the money typically. They don't have -- they've gone back to their LPs. They've gone back for 1 refinancing or 2 or small paydowns, and it's all taken much longer what the curve looked like. We were expecting a 3 forward curve. So against that, and then we had a Warner in, and we had the tariffs and the tariffs halted towels, rate cuts. He said, "I want to wait and inflation didn't show up really, but we all thought it would. I think the average man thought it would. And then you had this very powerful AI boom, which drove GDP growth, and then we have the war and inflation just took off and went the other way again. And so rates follow that. And so if you're a multi guy, you're expecting that the world would get better, faster, some markets are not great. You can look at the publics and see the different returns of the different geographies. The portfolio is on the coast are doing better than the Sunshine state. So we're seeing green shoots. We're seeing some of the south -- the smile states, the Texas, Tennessee, Florida. We're seeing city by city. You're beginning to see -- you see it first in less concessions. -- and then you see it in lower lease trade-outs. All of us, if we're renewing a tenant, we're getting rent growth. It's the new tenant that we're the least trade out where they went negative. Overall, I think you're positive 1 or 2 or something like that. And again, it's city by city. But it's definitely trending in the right direction. And again, because housing is getting hit hardest by the rate increases, new construction of single-family homes is going to collapse. It is falling, not actually collapsing. It's just down because the balance sheet to the builders are so good that they can continue to subsidize mortgages for buyers. So I think the press has gotten slightly wrong. The margins are coming in as they offer more and more have to come up with concessions, the form of mortgage buydowns. But the balance sheets for the homebuilders that are left, and they now dominate the market and free this period, they did not. But now these giant builders are like 60% of the housing market. And so I think overall, it just -- it is going to be a brighter future for sure.

The next question is from the line of Jade Rahmani with KBW.

Distributable earnings, excluding realized losses came in at $0.41. And just wanted to get your thoughts when the puts and takes, timing loan closings, repayments and where rates are today, do you think there's upward or downward pressure on that?

On the [indiscernible], Jade, we -- if I look back to Barry's comments earlier, last quarter, as he said, we looked out in that rate environment in we had a path to getting to the $0.48 that we said we were paying out with the new higher rates...

In a few quarters.

In a few quarters. Being at [ 41, ] I think we have -- our projections would be a little bit higher, but that's based on what we know today and not what we don't know yet that could happen. So yes, our projections are there or a little bit better. But...

I think you can use that as sort of a base earnings rate. And we have a lot of levers, right? So we have a lot of things we can do. But I think that's a reasonable number that -- and hopefully, as I mention goes up as we restore our can put this capital back to work as the kinds of returns we're getting in the stuff we're doing today.

And obviously, in retaining capital, we'll -- in creating capital will allow us to get that at up to the ports are reducing the accruals, which we're making progress on and continuing to grow. Our pace of growth has been really good. So if we can execute on that, our plan is to get this back up to where we had hoped it would be last quarter on the run rate.

And then the second question is just the CECL reserves you noted, the increase was mainly a macro model. It was a general reserve. No asset specific changes and no new nonaccruals. So it's kind of like a model formulation. That's correct. At the same time, we did see risk 4 and 5 rated loans increased, but then we saw NPAs decrease. So the question is if despite the model suggests are you seeing any new indications of defaults or nonperformance so far in the fourth quarter?

Yes. Listen, in -- as you headed into September 30, ultimate high in rates since September 30, right around there that week. And so if you look at the fourth and 5, there was people to make a decision on a 5-ish debt yield multi, do I continue to put money into that asset or do I hand it over. So given that we thought that the market might start capitulating, we definitely more cautiously moved people at the end of the quarter, which is when we mark book to a more of a 4 or a 5 stance. So I would expect that we're able to work out of 4s and 5s as quickly as anything new comes in. We don't know full effect of the September, October rate has. But as rates moderate to where we are today, I would expect that there is a significant decrease in a stop. Remember, we didn't have any new REOs or foreclosures for 2 quarters in a row. This move in September really drove us to make some moves on some of the lower debt yield assets that moved up to the 4 and 5 category and if rates moderate who know they could knock out.