TPG RE Finance Trust Inc

NYSE:TRTX

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the TPG Real Estate Finance Trust Third 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. Thank you. You may begin.

[Unknown Executive]

Thank you. Good morning and welcome to the TPG Real Estate Finance Trust Earnings Call for the third 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 Factors 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 to the press release and the Form 10-Q.

At this time, I'll turn the call over to Chief Executive Officer, Doug Bouquard.

[Doug Bouquard, executive]

Thank you. Over the past quarter, the Fed's initial rate cut and strong economic data across the board has fueled a remarkably broad rally in risk assets. For context, the forward price-to-earnings ratio of the S&P 500 is currently in the 97th percentile when compared to public market valuation multiples since the 1930s. Additionally, investment-grade and high-yield corporate spreads continue to trade at the tightest spreads since the GFC. Meanwhile, real estate is beginning to find its footing amidst the sentiment shift at large.

Transaction activity has ticked up and with it an increase in price transparency across property types. While the REIT index has rallied approximately 15% since mid-summer, the aggregate real estate recovery still meaningfully lags the broader equity market rally since the Fed began its hiking cycle in 2022. Real estate values generally remain below the 2021 peak values, which continues to provide an attractive entry point for lenders with dry powder. TRTX is positioned exceptionally well to take advantage of this opportunity set. As this macro picture has evolved, we see the key elements of an attractive real estate lending market developing.

First and foremost, banks continue to retreat from direct lending and instead are aggressively pursuing loan-on-loan lending. We see no sign of this capital shift slowing and continue to believe this tectonic shift will benefit the nonbank lending market for years to come. It reduces front-end competition for loan assets and improves liquidity and economic terms of back leverage. Secondly, the anticipated decline in short-term rates should increase borrower appetite for floating rate loans and when combined with a steepening yield curve, encourage some borrowers who plan to borrow from the fixed rate conduit or agency markets to pivot to floating rate debt.

As we assess the real estate credit landscape at large, we note 4 key ingredients that will drive the near-term investment opportunity set, an increase in transaction activity, which will drive further price transparency, combined with increased demand for floating rate borrowing while banks continue to retrench. Fortunately, TRTX distinguishes itself in terms of; one, an offensively postured liquidity position; two, an active new investment pipeline; and three, a high-quality credit profile as evidenced by stability in both risk ratings and CECL reserves. These attributes are further enhanced by the depth and breadth of TPG's broad and diversified investment experience, combined with its best-in-class integrated real estate debt and equity investment platform.

In terms of activity this past quarter, we received $149 million of repayments concentrated primarily in hotel, multifamily and mixed-use property types and made new investments totaling $204 million in sectors where we find compelling value, multifamily and hotels at a weighted average LTV of 63%. Given our robust liquidity position, we're actively pursuing new investments. In fact, our forward pipeline of potential new investments is at a level not seen since the Fed began its interest rate hikes in 2022. We remain very selective with our capital and acknowledge that risk premium have compressed across many asset classes. We continue to be patient investors as we thoughtfully deploy dry powder into the current market.

In summary, TRTX has a market-leading position as it plays offense, generates an 11.5% dividend yield, actively manages its loan portfolio and liability structure and thoughtfully allocates its investment capital. Furthermore, the real estate value recovery has lagged corporate value growth, which amplifies the attractiveness of investing in today's real estate credit market on both a relative and absolute basis. From an earnings perspective, TRTX possesses many levers to grow, including increased deployment using balance sheet cash, recycling of capital from REO and utilizing untapped existing financing capacity. Our current stock price implies a 27% discount to book value and offers public equity investors a compelling entry point to take advantage of the real estate credit opportunity set, enhanced by the insights of TPG's best-in-class real estate investing platform.

With that, I will turn the call over to Bob to provide a detailed overview of this quarter's financial results.

[Robert Foley, executive]

Thanks, Doug. Good morning, everyone and thank you for joining us. Our strong third quarter results reflect the consistent and thoughtful capital allocation strategy we continue to execute while maintaining a CECL reserve appropriate for our assessment of credit risk, actively managing our loan portfolio to encourage par repayments and positioning TRTX to invest in new loans. With strong liquidity of $357 million, leverage of only 2.02: 1, a CECL reserve of 205 basis points that's remained virtually unchanged for 3 quarters, a weighted average risk rating of 3.0 that hasn't wavered in 4 quarters, a 1.19x dividend coverage ratio for year-to-date 2024 and an active investment team, TRTX is well positioned to realize on the earnings power and build shareholder value.

Regarding operating results, GAAP net income attributable to common shareholders was $18.7 million for the quarter compared to $21 million for the prior quarter, reflecting an increase of $1.8 million in net interest margin and a decrease in credit loss benefit of $4.2 million. Net interest margin for our loan portfolio was $29.3 million compared to $27.5 million in the second quarter, an increase of $1.8 million or $0.02 per common share due to new loan investments and further optimization of our liability structure. Our weighted average credit spread on borrowings was virtually unchanged at 200 basis points compared to 197 basis points last quarter. Distributable earnings were $23 million or $0.28 per share compared to $22.3 million in the prior quarter.

Coverage in the quarter -- for the quarter of our $0.24 dividend was 1.7x and 1.19x for the first 9 months of 2024. Our CECL reserve declined by $0.3 million to $69.3 million from $69.6 million. This decline was due to solid collateral operating performance, slightly offset by new loan originations. We collected 100% of scheduled interest in the quarter. We had no 5-rated loans nor any specifically identified loans. Thus, we had no specific CECL loan loss reserve. Our CECL reserve was 205 basis points versus 208 basis points last quarter. We incurred no realized losses in the quarter. Consequently, book value per share increased to $11.41 from $11.40. We originated 3 loans totaling $204 million of commitments, funded $7.6 million of deferred fundings on existing loans and collected loan repayments of $149.3 million. Total loan investments increased to nearly $3.4 billion.

At quarter end, multifamily represented 54.5% of our loan portfolio. Office has declined 73% over the past 11 quarters to 18.1%. Life sciences is 11.7%, hotel is 10.3% and no other property type comprises more than 2.3% of our portfolio. Our primary investment themes remain housing, industrial, lodging and certain alternative property types, including self-storage. We have 5 REO properties comprising 5.1% of our total assets, 1 multifamily property and 4 office properties with a total carrying value of $188.5 million. Our powerful TPG real estate platform continues to drive improved operating performance, identify appropriate hold or sell strategies to optimize shareholder returns and execute disposition strategies for properties targeted. These 3 properties -- 3 properties are targeted for sale, and those properties are unencumbered by mortgage debt, thus their sale will generate substantial cash for reinvestment. We'll have more to report on those properties in February. Please refer to footnote 4 of our financial statements for a snapshot of our REO portfolio.

We have 2 4-rated loans. These borrowers may take the curative steps we require to cause the loans to remain outstanding or we may enforce our remedies, which include foreclosure. We'll have more to report on those loans in February after year-end. Our weighted average risk rating was unchanged at 3.0. Year-to-date, our borrowers infused $50.2 million of cash to pay interest, fund capital improvements, make partial principal payments on our loans or otherwise invest in their properties. Please refer to Page 54 of our Form 10-Q for more detail.

Our share of non-mark-to-market, nonrecourse term financing increased at quarter end to 79.7% from 78.7% at June 30, reflecting our historical emphasis on non-mark-to-market term funding of our investment portfolio. Total leverage was unchanged quarter-over-quarter at 2.02:1. Paired with $4.1 billion of financing capacity, our liability structure is prepared to support continued growth in earning assets in response to improving market dynamics. Our liquidity, pricing and loan investment ROEs continue to improve as we exploit TPG's capital markets platform to source new accretive non-mark-to-market financing. We expect all will help us 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.

We were in compliance with all financial covenants at September 30, 2024. We repurchased 4,603 shares during the third quarter under our share repurchase program. TRTX share price appreciation was 31.2% for the first 9 months of 2024, making TRTX the leading performer in the commercial mortgage REIT space. We've maintained an appropriate amount of immediate and near-term liquidity at 9.7% of total assets to support our growing volume of investment activity. Cash and near-term liquidity was $357 million, comprised of $211 million of cash in excess of our covenant requirements and $130.7 million of undrawn capacity under our secured credit agreements. We also have $35.7 million of aggregate unpaid principal -- in aggregate unpaid principal balance of unencumbered loan assets.

During the quarter, we funded $7.6 million of commitments under existing loans. And at quarter end, our deferred funding obligations under existing loan commitments totaled only $122.3 million, a mere 3.6% of our total loan commitments. We continue to believe that TRTX offers a tremendous value proposition to investors. We have a strong management team -- excuse me, we have a strong investment team, low leverage, a liability structure that is 80% non-mark-to-market, stable credit ratings and a stable CECL reserve, a loan portfolio that is 100% current with no 5-rated loans, strong potential for earnings growth, an 11.5% dividend yield on current market value and we're trading at 73% of book value.

Despite all these market-leading attributes, the market still imposes a 27% discount to book value. This $245 million discount is 3.7x our current CECL reserve of $66.7 million for [ funded ] loan balances. This is inconsistent with empirical data. Our CECL track record has historically closely approximated realized losses for our resolved loans.

In summary, TRTX again delivered the strong operating performance, growing investment activity, stable credit ratings and CECL reserve, low leverage, substantial liquidity and capacity for earnings growth that are hallmarks of TRTX.

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

[Operator]

[Operator Instructions] Our first question comes from Stephen Laws with Raymond James.

[Stephen Laws, analyst]

Doug [indiscernible] you mentioned a couple of ways to grow. Just curious on your thoughts around leverage in the loan book. Are you really comfortable here and focus more on reinvesting repayment proceeds? Or are you comfortable increasing leverage as we move through the next 2 quarters?

[Doug Bouquard, executive]

Yes. I mean from an investment perspective, we continue to see a number of levers where we can grow our earnings power, which I had mentioned within my initial transcript. And what we're seeing really on the ground is, we are seeing repayments. I think that there's a little bit of push and pull as to where the 10-year settles. I think as the 10-year creeps up a little bit, that in some ways can slow certain repayment activities if a borrower is considering a fixed rate financing. But on the other side, that is, I think, pushing more borrowers towards the floating rate market. So that's kind of one comment on the sort of front end.

And then in terms of back leverage, look, I think the company, generally speaking, is very modestly levered, both on an absolute basis but also relative to the rest of the market. So I do anticipate that as we're out there deploying more capital that our leverage will increase. And when we think about all the potential levers and again, Bob mentioned, we also have levers in terms of recycling capital from REO and then also utilizing untapped financing capacity. But again, from a balance sheet cash perspective, I do expect that we will be using a portion of that balance sheet cash to also drive new investments and very likely increase leverage at the company level.

[Stephen Laws, analyst]

Yes, that's great. That was kind of a follow-up question I had was around those REOs. I guess -- I think Bob mentioned [Technical Difficulty] kind of evaluating sales, you'll have more to say early next year. If you think about recycling that capital, none of them have debt. So kind of what is the incremental return pickup as you think about that capital moving out of unlevered real estate [Technical Difficulty] levered CRE loans pipeline?

[Robert Foley, executive]

Doug, do you want me to take that?

[Doug Bouquard, executive]

Yes. Bob, go ahead.

[Robert Foley, executive]

Great. Good question, Stephen. You're right, the 3 properties that we're currently marketing for sale, none of them are levered with mortgage debt. The straight answer to your question is, it depends on which property is being sold. But generally speaking, ROEs in our loan investment business right now are above 9%. Some of the REO properties that we own have yields in excess of that. Others have yields that are below. And that information is contained in the footnotes to our financial statements. So it sort of depends on which asset is sold. But generally speaking, we believe that recycling the capital as we repatriate it into new loan investments will be accretive to the company's earnings, in rough terms and you can pick your own REO -- ROE, excuse me, return on equity for our investments, every $100 million of deployed equity capital or recycled capital equates to about $0.03 per share per quarter. I hope that answers your question.

[Stephen Laws, analyst]

Yes. No, I appreciate the specifics there. That's great, Bob. And lastly, Doug, I want to touch on life sciences. A couple of your peers have said that they're now on their watch list REO. It's about 11% or 12% of your portfolio in 2 of your top 10 loans. So can you maybe touch on that property type, talk about, in your general reserve how you think about the allocation of the general reserve to those life sciences exposures and maybe [Technical Difficulty] those assets are in their business plans.

[Doug Bouquard, executive]

Yes. Well, first, I think as Bob had mentioned, we -- I think we have a really strong track record around where we set our reserves as it is meant to reflect our expected view of loss over the life of a loan, one. Two, when you think about life sciences, first and foremost, it's an important sector within TPG broadly. The firm has built a successful franchise investing in life science companies. And then also on the real estate side, within the equity business, we own and operate a large portfolio of life sciences properties. So in short, it's a sector that we know incredibly well from really a sort of variety of angles. When we think about it through the lending lens, we've been actively lending in this market since 2015. So again, very familiar, very, very knowledgeable.

As it relates to our current portfolio, we have 4 loans in life sciences, again, to your point, comprising a little over 10% of the portfolio. Two of the properties are nearly stabilized with occupancy nearing or exceeding our underwriting. And then 2 that have been fully converted to lab space and are basically currently in lease-up. So when we think about our risk, we really kind of center on the tremendous depth of experience here at TPG in investing in the space, one. And then two, we really believe that the borrowers that we have here are the right sponsors to execute on these business plans. And frankly, there's been significant progress on each deal in that regard.

[Operator]

The next question comes from Steve Delaney with JMP Securities.

[Steven Delaney, analyst]

Congrats on how you positioned your credit profile. It's really -- it's exceptional. So congrats on that. Now that we are where we are and you're not in workout mode, just curious [Technical Difficulty] and what you're seeing, Doug, in the marketplace as far as opportunities. Do you have sort of a target level given the existing capital base on where you think over 6 to 12 months, you might be able to grow the portfolio? I mean you were $5 billion back at the end of 2022. And admittedly, there's a couple of hundred million of equity that is not around anymore. But just curious kind of a round figure of where -- if you have a target of where you can be in the next 6 to 12 months in the loan book.

[Doug Bouquard, executive]

Yes. Look, I think that -- we obviously can't provide forward guidance but I'm happy to kind of share, I think, some more commentary on really a few of those levers. And really, I think all those levers point to growth in terms of our outstanding loan book. Again, I think the first lever, to be clear, is going to be deploying balance sheet cash, right? I think that you can see from our liquidity profile, we have ample liquidity. So I do expect that's effectively 1 area where we'll be able to grow the balance sheet. If you use, again, a 2:1 leverage ratio, let's just say, on new investments, that means that, let's call it, approximately $33 million of equity can fuel approximately $100 million of new loan investments, just to give kind of 1 number. And then, Bob, had sort of mentioned kind of what $100 million of investment activity will do in terms of driving earnings on a quarterly basis.

When we think about the other levers, first of all, the recycling of capital from REO, I think as Bob had mentioned, it's -- we're in the market right now with 3 of our 5 REO assets and we'll have a more robust update for the market over the next quarter. But that, again, will provide very clear path towards growing our outstanding loan balances. And then lastly, we are somewhat under-levered in terms of our existing financing capacity and that's where also we have yet another path for us to be able to grow our investment portfolio. So again, think we're unique in that we do have all of those levers, one. And then we're combining that with an opportunity set that we frankly haven't even experienced yet in sort of real estate lending with banks pulling back from direct lending and then also being more aggressive, I would say, on the loan-on-loan side.

And when we see the loan-on-loan quotes that we're getting, they are, in many cases, inside of the spreads that we're seeing within the [indiscernible] CLO market. So it does provide a really great stable source for us to be able to grow our investment portfolio given really all those vectors that are kind of pointing in our direction.

[Steven Delaney, analyst]

And I applaud the share buybacks certainly at a 25% discount to the stock on book. Just curious as you look at the capital mix going forward, do you see a place for high-yield debt? I mean, obviously, the bond market is sold off but about 70 basis -- 60, 70 basis points higher, I guess, now on the 10-year. But if things were to come back down as the Fed proceeds, does the 5-year notes, the 5-, 7-year unsecured notes make sense for TRTX just to mix in a little corporate leverage to your financing mix?

[Doug Bouquard, executive]

Yes. Look, I mean, Bob and I are constantly looking at ways that we can appropriately and efficiently lever our balance sheet. So I think that in the past, we have a record of, I think, being really tactical and thoughtful as to how we capitalize ourselves. With risk premium in the corporate market continuing to remain tight, I think that -- I do expect that we will be looking into that market over time, frankly, as we lever our balance sheet back up. I think for us, our sort of near-term focus, again, is going to be maximizing those levers that I mentioned in terms of balance sheet cash, recycling of capital and then utilizing untapped financing capacity as big drivers. But available financing alternatives are definitely abundant across, again, both the asset market on a loan-on-loan basis and also at the corporate level. So you should just expect that we'll be utilizing every possible kind of tool in the toolkit as it comes to appropriately levering the balance sheet.

[Operator]

The next question comes from Don Fandetti with Wells Fargo.

[Donald Fandetti, analyst]

Can you talk about the risk of migration of 3-rated loans to 4 rated? And I have a follow-up as well.

[Robert Foley, executive]

Thank you for the question, Don. A couple of points on that. First, as both Doug and I mentioned in our prepared remarks, we had no risk migration in any direction during the quarter just ended. I think more importantly, some comments on how we manage that process and what the empirical data tells us about migration behavior over time. First, we do -- we spend a lot of time asset managing our loans, as I think people on the call are aware. We do portfolio reviews on a quarterly basis. We assign or revisit risk ratings at least quarterly. And frankly, we review recent developments on some loans even more frequently than that.

We've looked at our risk rating migration over time. And I think that what's interesting to note, we've mentioned this before on calls, is that, for us at least, the majority, about 2/3 of the loans that we see migrate from 3 to 4 end up resolving in a normal way. Typically, the borrower repays us either through a refinancing or a sale. And that's been true over the period that includes the post-COVID environment. Some loans that fail to keep up with their underwritten business plan over time are going to migrate to 4 or at least they have in the past. Whether that happens in the future is a very loan-by-loan issue. And then obviously, some assets do migrate to the 5 category, although that pace has slowed considerably over the last couple of years. So I hope that answers your questions.

But the fundamental thing is, migration does happen. It hasn't happened in our portfolio recently. When it does and it's a migration to 4, the more likely than not outcome is that the loan is resolved at par. Don, you said you had a follow-up question.

[Donald Fandetti, analyst]

Yes. As I think about book value near term, I guess, the -- first of all, it's good to see another quarter of stability overall on credit. But as I kind of think about stressing the book value risk, I guess, the 4-rated loans, the $200 million, you could potentially have to put more reserves on those if they move to 5. But then I guess on REO, it sounds like you're feeling pretty good about your [ basis ] versus where those sales could be executed. Is that the right way to think about it?

[Robert Foley, executive]

Well, I think there are 2 questions there. Let's talk first about REO. The accounting rules and our business discipline are both very clear, when a company acquires an asset through foreclosure, deed in lieu, what have you and it becomes REO, you take that asset on your books at then market value. All of our REO assets have been acquired over the past year. So they're, in our view, current values or at least they were at the time that the properties were acquired. So if that were not the case, then we would have booked or we would need to book a write-down and we haven't.

And we'll have more, as Doug said, and as I said, next quarter to report on the outcome of these sales processes. With respect to the need to book more reserves, this gets to some fundamental issues about CECL and its application. CECL, by definition is intended to represent management's expected losses on a loan over its -- the life of that loan. So needing to build more reserves shouldn't be necessary based on what a registrant knows about its loan book today and what it expects will happen with that loan in the future.

So we're comfortable with our CECL reserve. It's been very stable for almost 1 year. And if facts and circumstances on individual loans change over time, then that will get reflected in the following quarter's CECL analysis. But as you've seen, our risk ratings have been quite stable. The portfolio is performing well. We've identified the assets that are 4, is where we're pretty focused and we're just doing our work. And I think our body of work over time suggests that we do a good job in terms of asset managing and resolving credit challenged loans when they arise.

Any further follow-up there?

[Donald Fandetti, analyst]

[indiscernible]

[Robert Foley, executive]

Okay. Thank you.

[Operator]

The final question comes from Rick Shane with JPMorgan.

[Unknown Analyst]

This is A.J. on for Rick. Can you tell us a little bit more about what your origination pipeline looks like? Where are you seeing the most attractive opportunities right now?

[Doug Bouquard, executive]

Of course. So right now, from an investment perspective, we continue really to focus primarily on multifamily and industrial. I think as we mentioned earlier in the call, we will look at other property types selectively. But multifamily and industrial continue to be 2 sectors where we have strong conviction in terms of the long-term secular demand on the assets, one. Two, I think as we've seen transaction activity pick up on the margin, again, we're nowhere near back to where we were a few years ago, that activity has largely been concentrated within multifamily and industrial. And I do expect that as we begin to see the front end of the curve go a bit lower that, that's only going to increase acquisition activity and also borrowers' willingness to frankly take on a transitional business plan, which is exactly really where we have the sort of core of our lending exposure currently and frankly, where we will be lending.

So when we look at the forward opportunity set, again, it's primarily multifamily and industrial, one. Two, I think one thing that I sort of highlighted is when you look at the real estate values versus particularly even where the sort of corporate market is valued, real estate values have really lagged on a relative basis. And why that matters for our company is that it just provides an incredibly attractive entry point from a loan-to-value perspective. So simply put, if we're lending today, I mentioned that our investment this quarter blended to about 63% LTV. Because values are generally down from the very peak, we're actually lending at a lower LTV relative to peak values, which is very different from most other parts -- or frankly, broader credit markets.

And then I would say, lastly, again, I can't highlight enough the sort of appetite on the back leverage side. So what that also means is that not only do we have ample liquidity and generally attractive terms on the back leverage side, as spreads there go tighter, that allows us to originate loans at marginally tighter spreads on much lower credit risk assets while still being able to generate mid-teens gross returns on these investments. So it's a really powerful combination of, frankly, 3 big drivers.

[Unknown Analyst]

Okay. And then can you also just give us an update on your share repurchase plans? How are you weighing against that -- against the current share price or versus doing more originations?

[Doug Bouquard, executive]

Sure. I'd say that we are looking at both actively. And I shared a lot about kind of how we're thinking about originations and some of the levers that we have that are at our disposal to be able to pull. But on the share repurchase side, look, I mean, we purchased, frankly, a modest amount of shares this past quarter. What I can share is that the repurchase plan remains in place. And frankly, we continue to view share repurchases as an attractive means of allocating shareholder capital.

[Operator]

At this time, I would like to turn the call back to management for closing comments.

[Doug Bouquard, executive]

Thank you for joining our call this morning and we look forward to updating you on the progress here at TRTX in the next couple of months. Thank you.

[Operator]

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.