TPG RE Finance Trust Inc

NYSE:TRTX

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to TPG Real Estate Finance Trust Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded.

It is now my pleasure to turn the call over to the company.

[Unknown Speaker]

Good morning, and welcome to TPG Real Estate Finance Trust earnings call for the second quarter of 2024. We are joined today by Doug Bouquard, Chief Executive Officer; and Bob Foley, Chief Financial Officer. Doug and Bob will share some comments about the quarter and then we will open the call for questions.

Yesterday evening, the company filed its Form 10-Q and issued a press release and earnings supplemental with a presentation of operating results, all of which are available on the company's website in the Investor Relations section. As a reminder, today's call is being recorded and may include forward-looking statements, which are uncertain and outside of the company's control. Actual results may differ materially. For a discussion of risks that could affect results, please see the Risk Factor section of the company's most recent Form 10-K. The company does not undertake any duty to update these statements. And today's call participants will refer to certain non-GAAP measures. And for reconciliations you should refer the press release and the Form 10-Q.

At this time, it's my pleasure to turn the call over to Chief Executive Officer, Doug Bouquard.

[Doug Bouquard, executive]

Thank you very much. Over the past quarter, the U.S. economy and financial markets have continued to exhibit resiliency as the soft landing narrative gains momentum. Recent CPI data suggests this inflation is underway and more accommodative financial conditions may be just around the quarter. Corporate credit spreads remain near the post-GFC ties and the securitized debt markets have been actually a bright spot year-to-date. CMBS issuance has already matched all of 2023's volume, driven primarily by heavy SASB offerings in the first half of 2024.

Despite the positive tone across most asset classes, the combination of elevated geopolitical risk and an uncertain election season, reminds us of how quickly demand for risk assets can pivot as we head in the second half of 2024. While we do see signs of recovery within the real estate sector broadly, it does continue to lag relative to the broader market rally. In the face of an uneven recovery in the real estate market, certain themes remain consistent. Acquisition activity remains modest relative to peak. Banks continue to pivot away from direct lending and towards providing one on one capital. And lastly, elevated front end interest rates continue to put pressure on certain real estate capital structures.

We're at a point in the cycle where dispersion and idiosyncratic outcomes will remain constant with real estate investment. Asset, property type, market level and capital markets intelligence is critical and we're fortunate to have the depth and breadth of TPG's integrated global debt and equity platform at our disposal. Over the past quarter, TRTX investment approach has remained steadfast; maintain ample levels of liquidity, proactively risk manage our balance sheet and selectively identify new investment opportunities.

Our results demonstrate the benefits of the strategy. Our portfolio is 100% current. We have no vibrated loans and we have a growing investment pipeline. Furthermore, our risk ratings remain constant, while we reduced our CECL reserves. With the continued strong portfolio performance of robust liquidity position and an offensive posture, TRTX is well positioned to take advantage of the opportunities within the real estate credit market, particularly as we head to the end of the year.

In terms of noteworthy activity this quarter, we received $186 million of repayments during the second quarter, over half of which were office loans repaid in full. On the new investment front, our pipeline continues to grow. We funded a $96 billion multifamily loan 2 days after quarter end. With the softening in CMBS spreads over the past few weeks, we do expect borrower demand for floating rate loans to pivot from CMBS to other lending channels, including TRTX and the broader non-bank lending market.

With respect to our balance sheet, we continue to maintain robust liquidity with over $389 million of cash and undrawn credit capacity from our secured lenders. We finished the quarter with a 2:1 debt-to-equity ratio and are positioned to accretively grow the balance sheet and the opportunity that evolves. With the experience and resources of TPG's global real estate platform, we are uniquely positioned to maximize shareholder value on our existing balance sheet and identify attractive new investments.

In summary, we're excited about TRTX positioning relative to competitors across the non-bank lending space. As we evaluate new investments, we remain highly selective given the uneven nature of the real estate recovery. As banks withdraw from direct lending and the opportunity set grows for the non-bank lending community, a solid balance sheet, ample liquidity and a best-in-class global real estate investment platform provides the foundation on which to drive shareholder value over the long-term.

With that, I will turn it over to Bob for a more detailed summary of our quarterly results.

[Robert Foley, executive]

Thank you, Doug. Good morning, everyone. Thanks for joining us. Our second quarter results reflect an increase in net interest margin, a loan portfolio that remains 100% current and the decline in our CECL reserve of $4.5 million or 6.1%, reflecting $186.1 million of loan repayments, along with solid operating performance of our loan collateral.

GAAP net income attributable to common shareholders was $21 million as compared to $13.1 million in the preceding quarter. That increase was due almost entirely to a quarter-over-quarter reduction in credit loss expense of $8.9 million, driven by a $4.5 million reduction in our CECL reserve for the second quarter compared to a $4.4 million increase in the first quarter of this year. Net interest margin for our loan portfolio was $27.5 million versus $26.8 million in the prior quarter or $0.01 per common share due to reduced borrowings and further optimization of our liability structure. Our weighted average credit spread on borrowings was virtually unchanged at 197 basis points.

Distributable earnings were $22.3 million or $0.28 per share. Coverage in the quarter for the quarter of our $0.24 dividend was 1.17x and 1.21x for the first 6 months of this year. Our CECL reserve declined by $4.5 million to $69.6 million from $74.1 million or $0.06 per share. This decline was due primarily to solid collateral operating performance and a quarter-over-quarter net decline in UPB of $168 million. All of our loans were current. We had no 5-rated loans, more specifically identified loans, thus we had no specific CECL loan loss reserve. Our CECL reserve was 208 basis points versus 210 basis points last quarter.

We incurred no realized losses in the quarter. Book value declined $0.41 per share to $11.40 from $11.81, reflecting the net impact of, first, distributable earnings per share exceeding our dividend by $0.04; second, the $0.06 per share reduction in our CECL reserve; and third, a $0.39 per share decline due to the delivery on May 8 of 2.6 million common shares of TRTX relating to a warrant exercise. No warrants remain outstanding.

Regarding our loan investment portfolio, multifamily now represents 52.5% of our loan portfolio, office has declined 73% over the past 10 quarters to 18.4%, life sciences 12.1%, hotel is 10.4% and no other property type comprises more than 3.4% of our book. Office loan UPB declined by $95.8 million, representing 51.5% of total loan repayments received during the second quarter. That was due primarily to the par repayment in full of 2 office loans, 1 in Atlanta and the other in the [indiscernible] submarket of the Bay Air.

At quarter end, total office UPB was $587.5 million across 6 of our 48 loan investments. We had no new loan originations during the quarter, but we did close on July 3 at $96 million first mortgage loan on a 2-property portfolio of leased multifamily whose closing split from the last week of June to the first week of July. Our sizable pipeline is populated with quality transactions that fit our strike zone.

Regarding REO, we have 5 REO properties comprising 5.2% of our total assets, 1 multifamily property and 4 office properties with a total carrying value of $190.4 million. Using the depth and breadth of TPG Real Estate's platform, we continue to drive operating performance and finalize near-term disposition strategies for properties that would otherwise require significant capital investment and longer hold periods. This portfolio currently contributes $0.04 per share to our distributable earnings. Please refer to Footnote 4 of our financial statements for a snapshot of our REO portfolio.

Regarding credit, our weighted average risk rating was unchanged at 3.0. All of our loans were current. Refer to Page 53 of our 10-Q for more detail. Regarding liabilities and capital base, the share of non-mark-to-market, non-recourse term financing increased at quarter end to 78.7% from 77.1% at March 31. Total leverage declined to 2:1 from 2.2:1 at March 31. We have $4.1 billion of total financing capacity across 11 different arrangements. In June, we opted to terminate rather than renew a $500 million secured credit facility with Morgan Stanley due to non-use. We repaid $1.8 million of borrowings upon termination.

Liquidity and pricing in the market continue to improve for financing provided in a non-direct lending from large and mid-sized banks. Combined with unchanged to slightly wider loan spreads on new loan investments, our ROEs are stable to improve. We completed in April, the reinvestment of the final $51 million of cash in our FL5 CLO. The reinvestment windows are now closed for all 3 of our CLOs, although we remain able to substitute and exchange loans under certain circumstances.

We continue to monitor the CRE CLO market as a tool to further optimize our cost-efficient, highly non-mark-to-market liability structure, either refinancing existing CLOs, financing loan investments that are currently unencumbered or to finance new loan investments. Presently, the note on note market continues to hold greater appeal to us due to more favorable structure and money terms. We were in compliance with all of our financial covenants at June 30, 2024. We repurchased no shares during the second quarter under our share repurchase program, largely because our share price appreciated by 11.9% during the quarter. TRTX's share price appreciation was 41.2% for the first 6 months of this year.

We maintain an appropriate amount of intermediate and near-term liquidity at 10.5% of our total asset base. Cash and near-term liquidity was $389.4 million at June 30 compared to $370.7 million at March 31 comprised of $244.2 million of cash in excess of our covenant requirements and $127.7 million of undrawn capacity under our secured credit agreements. During the quarter, we funded $18.1 million of commitments under existing loans. At quarter end, our deferred funding obligations under existing loan agreements totaled only $139.6 million, nearly 4.2% of our total loan commitments and less than half of our current liquidity. In summary, the second quarter was characterized by strong operating performance, solid credit, further optimization of our liability structure and significant liquidity to support opportunistic capital allocation.

And with that, we'll open the floor to questions. Operator?

[Operator]

[Operator Instructions] Our first question is from Tom Catherwood with BTIG.

[William Catherwood, analyst]

Doug, maybe going back to something that you had mentioned in the opening, just as a thought of widening CMBS spreads, driving more demand for your floating rate products. Is this kind of helping populate your post 2Q pipeline? Can you provide some more color around that?

[Doug Bouquard, executive]

Yes, sure. Happy to. And bear in mind that we as a platform are also a borrower in the CMBS market. So we do share some pretty unique perspectives. But really what happened in the CMBS market is you saw a pretty meaningful spread tightening, pretty much beginning from January, up until about the month of June. And in the month of June, what you began to see is spreads widen I think really as a function of too much supply in the market. So there was definitely a period of time during Q2 where more of the floating rate market share was basically taken by the CMBS market. And we do expect that given the recent widening that could drive more and more activity in our pipeline, and we are beginning to see that, one.

And then two, I would say, CMBS does have its limitations in terms of the types of assets that get financed. We are fundamentally looking at primarily position transitional assets. So we sort of have the benefit of both certain assets that perhaps would have gone to CMBS, we can now let that financing them. And then I would say, secondly, as there is some of that of recovery within the real estate market, we're seeing borrowers begin now to think through value-add business plans, which do require floating rate financing that really can only be financed outside the CMBS market. So in short, we definitely do this to be a driver of activity going in the second half of the year.

[William Catherwood, analyst]

That's very helpful color. And then as that relates to the pipeline specifically, I know the multifamily closing pushed from June into July, but can you put some maybe numbers around how the pipeline today compares to where it was at the beginning of either 2Q or the start of the year? Is there a sense of how much that has grown in scale?

[Doug Bouquard, executive]

Yes. I mean, look, I think from a pipeline perspective, we're seeing a tremendous amount of deals right now across really a variety of different property types. From a measurement perspective, we at any time may have up to 60 to 70 deals within our pipeline. And I would say, recently, there's been an increase, but again, it's been largely driven by the fact that you're seeing CMBS pulling back and we are basically able to kind of fill in for where that gap is. So I would say that there's been a substantial increase and really at the lows, which I would say was probably Q4 of last year. I would say, anecdotally, we're probably seeing nearly about a 50% increase in terms of some of the activity based on how we track the pipeline.

[Operator]

[Operator Instructions] Our next question is from Stephen Laws with Raymond James.

[Stephen Laws, analyst]

Following up on the origination question, can you maybe talk about how your appetite for new investments balances against your expected repayments in the second half of the year? And kind of is the portfolio size going to increase over the back half, stay the same or do you expect some additional run-off here in 3Q?

[Doug Bouquard, executive]

Yes, sure. I'll share a few things really about how we're thinking about investing and quickly as it relates to our repayment pace. First and foremost, well, it really drives all of our new investment activity is being highly selective. I mentioned in my comments that sort of phrase it there being this uneven real estate recovery really kind of littered with many idiosyncratic outcomes. And really that's how we're looking across the landscape is acknowledging that it's not just going to sort of all bounce back with a correlation of one across property types, it's frankly very idiosyncratic. So at the top of the list is we remain selective, one.

And then, I would say, two, as it relates to property type specifically, I think you'll still see somewhat of a housing bias coming from us really across the multifamily space where we do see both a good amount of opportunity and dislocation, which for us as a lender is very attractive. And then I think on your final comment about repayments, it's a great question. I think there are obviously some micro and macro factors that will weigh on the pace of our repayments. I would say, on the micro side, again, it's actually of course vary loan-by-loan. For example, we had two pretty substantially sized office loans pay off this past quarter, which we did expect to pay off, but the exact timing can at times be part of maybe nailed down to the sort of week or even day. But generally speaking, from a repayment perspective, we are starting to see a little bit more of a pick-up. And I would expect that between now and year-end, multifamily could see perhaps a bit of repayment activity as you are seeing capital markets loosen up, particularly within multifamily.

And I think finally, on the sort of macro point, which we're obviously very focused on and in many ways, this will be a much bigger driver is, if we do sort of encounter easing financial conditions in the front end of the curve does, it does go lower. I think that will definitely potentially open up some amount of reasons within the -- within our balance sheet. Part of that driven by borrowers perhaps once again able to get what they would view as attractive financing to continue on their business plan and they may want to pay our advances off.

So again, it's a mix of really micro and macro, but we do acknowledge that the one overlaying factor as we think about new investments, which is pretty unique, as we've been talking about the sort of pullback of bank lenders for many quarters. But we may encounter the first time it's sort of recent history where there is a pullback in bank lending, but the demand from the borrowing community will be in transitional assets. And I think a lot of what we've seen so far has been a little bit more oriented towards stabilized assets. So I think we're really set-up very well for this technical potentially front end rates going lower, banks pulling back and I think TRTX being well positioned from a liquidity perspective to be able to take advantage of that -- of the potential gap.

[Stephen Laws, analyst]

And a follow-up question, I wanted to kind of touch on the 4-rated models. Are there any second half events or milestones that are to be instrumental as you look at those 4 loans and whether they move back to 3 or potentially have internal problems? And then specifically, any update on the San Antonio loan? I think there was a news article maybe that mentioned that was moving to a foreclosure sale. So curious if there's an update there.

[Robert Foley, executive]

Sure. Thanks for your question, Stephen. First, the macro and then we can talk specifically about San Antonio. On the macro front, 4-rated loans are clearly behind their business plan, but their eventual resolution could take a number of pads. And as we've discussed on previous calls, historically, a large proportion of 4-rated loans actually resolved without incident.

With respect to the specific four-rated loans right now, we're all over each of them. And basically, we're working with borrowers to ensure that they're prepared to commit the capital that's needed to frankly bridge those loans to an eventual sale or refinancing. There's dispersion within that population. Some are probably closer to the boundary of the 3 and some are probably below the mean as well. I think the post Labor Day season will be pretty important as we get closer to the election in terms of how some of these things play out.

With respect to San Antonio, there were several published reports that we had filed a notice of foreclosure sale on a 2-property multifamily portfolio in San Antonio that is not meeting its original business plan. San Antonio is a solid, affordable multifamily market. Having a -- Texas is a state in which it's relatively straightforward and quick to foreclose and it's a good huddle to use when negotiating with the borrower over terms of the modification. That's the current state of play. We told the sale that was originally posted in July because the borrower took certain steps and actually infuse more capital into the transaction. And that's a story that will continue to play out probably over the next couple of months.

[Stephen Laws, analyst]

And then one last follow-up. On the REO assets, I know it contributed $0.04 of distributable earnings this core REO in Q2. Can you talk about maybe which one of those -- what are the 1 or 2 that are potentially the bigger drags on earnings that if you kind of got that capital freed up to be recycled could be the biggest lift to earnings, similar loans I'm sure there's a dispersion of performance across those 5 assets?

[Robert Foley, executive]

Yes. We own 5 properties as you and others on the call know. We own 1 multifamily property. That is a contributor to NOI. We've increased under our ownership occupancy in that property from the high-70s to the low-90s. So we're pretty pleased with the operational changes that we've been able to affect at the property level and the market seems to be responding to that.

So that an office property in Houston and an office property here in New York are all contributors. The other 2 properties, both of which are in California, are effectively breakeven right now. Those are the ones that we're pretty focused on in terms of evaluating alternative business plans, whether additional capital will be required and whether the re-buy analysis suggests that the best thing for shareholders is for us to invest or to sell. And as we have stated before, I think a lot of that will become much clearer between now and Thanksgiving.

[Operator]

[Operator Instructions] Our next question is from Steve Delaney with Citizens JMP.

[Steven Delaney, analyst]

Congratulations on a very clean quarter. I expect we won't see many quite this clean over the next couple of weeks. Nice job. I wanted to ask about the CECL reserve, came down $4 million to $5 million. Is that -- was that due to -- simply due to pay-offs in the quarter that caused the CECL reserve to drop?

[Robert Foley, executive]

Well, I would say that there were 3 factors. One, as you point out, is we did have a reduction in total loan UPB, which is subject to the CECL estimate process.

I'd say, the second factor is the macroeconomic assumptions that drive the Monte Carlo model that develops the estimates for our general reserve, and all of our reserve right now falls into the general category. And I would say that those assumptions were on average a little bit better than last quarter, especially with respect to rates and a slowdown in the pace of property depreciation -- property value depreciation.

And then I think the third thing and probably the most important of the 3 factors is the operating performance of most of our collateral has been pretty solid. And so that's reflected largely in the debt service coverage ratio, which is an important variable in the predictive model itself. So those are the 3 factors.

[Steven Delaney, analyst]

Got it. And as the portfolio starts to rebuild, obviously, you've got your big multifamily loan in July. Did we -- we're projecting some net portfolio growth. Given your low leverage, it would seem to me that that's reasonable in an improving market opportunity. How should we think about building the general reserve? I mean, you're 200 basis points roughly right now. But does it -- will it take 200 or can we build at maybe 150? Any thoughts just the range if we were trying to model out over the next year or two, how much general CECL build would you suggest we put into our models?

[Robert Foley, executive]

Thanks for your question. Well, first, I'll offer an editorial comment, which is that I try to avoid the use of word build with respect to CECL reserves because that's exactly what FASB was seeking to avoid when they've established this new pronouncement back in early 2020. I think that perhaps a helpful construct would be the purpose of CECL is to develop a forecast of expected losses over the life of the loan. We are now investing in a very good credit market as a lender where we have much lower entry points per square foot, per unit, per key than we did several years ago. And so -- and those are all important inputs into the predictive model that we use.

So the rate that you see with respect to our current portfolio largely reflects loans that were originated between -- at the old end 2018 or '19, but most of them were originated in '21 through '23. We've moved into a new era where arguably the risk profile is higher in-place debt yields, lower LTV, lower absolute dollar basis per unit of real estate. All else being equal, macroeconomic assumptions and so forth, that's going to produce a lower rate. So what I would suggest is perhaps you want to go back and look at loan losses or what people's estimates were prior to COVID and draw some inspiration from that.

[Operator]

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Mr. Bouquard for closing remarks.

[Doug Bouquard, executive]

Just wanted to thank everyone for joining our call today, and we look forward to updating you on continued progress. Have a great day. Thank you.

[Operator]

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.