TPG RE Finance Trust, Inc. (NYSE:TRTX) Q4 2022 Earnings Call Transcript

TPG RE Finance Trust, Inc. (NYSE:TRTX) Q4 2022 Earnings Call Transcript February 22, 2023

Company Representatives: Doug Bouquard – Chief Executive Officer Bob Foley – Chief Financial Officer Deborah Ginsberg – Vice President, Secretary, General Counsel

Operator: Greetings, and welcome to the TPG RE Finance Trust, Fourth Quarter 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Ginsberg, Vice President, Secretary and General Counsel. Thank you, Deborah. You may begin.

Deborah Ginsberg: Good morning, and welcome to TPG Real Estate Finance Trust conference call for the fourth quarter and full year 2022. I’m 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’ll open up the call for questions. Yesterday evening we filed our Form 10-K and issued a press release and earnings supplemental with a presentation of our operating results, all of which are available on our website in the Investor Relations section. I’d like to remind everyone that today’s call may include forward-looking statements, which are uncertain and outside of the company’s control. Actual results may differ materially.

For a discussion of some of the risks that could affect results, please see the Risk Factors section of our Form 10-K. We do not undertake any duty to update these statements and we’ll also refer to certain non-GAAP measures on this call, and for reconciliations you should refer to the press release and 10-K. With that, I will turn the call over to Doug Bouquard, Chief Executive Officer of TPG Real Estate Finance Trust.

Doug Bouquard: Thank you, Deborah, I appreciate it. Good morning and thank you all for joining the call today. The real-estate market continues to adjust to a myriad of challenges and opportunities. On one hand, tighter financial conditions, reduced liquidity and greater dispersion of risk appetite across property types and markets have put pressure on values. But on the other hand, a strong labor market and resilient economy continues to support a positive outlook on the long term fundamental real-estate valuation. Fortunately for TRTX, we identified and began to prepare for tightening financial conditions during the first half of 2022 as we bolstered our liquidity profile and increased our selectivity for new investments. For TRTX this past quarter was no different and that we continue to selectively invest with a cautious eye on liquidity, while proactively risk managing our existing portfolio.

In 2022, TRTX originated or acquired $1.7 billion of new loans, approximately 80% of which were multifamily, industrial or self-storage. Three sectors we continue to target given their long term fundamental tailwinds. In addition, we’ve been very disciplined on the nature of our financing. 65% of our 2022 investments were financed on a non-mark-to-market basis. Furthermore, over the past year we strategically increased our multifamily and industrial exposure by 62%, while reducing our office exposure by over 32%, which is the greatest year-over-year reduction of office exposure amongst our peers. In the aggregate, loan principal payments for the year 2022 equaled $1.5 billion, and our repayments attributable to our office loans comprised 44% of that number.

While we continue to acknowledge the dislocation of lending markets and pressure on value within certain sectors and geographies, particularly office properties, you can see it from our quarter-over-quarter seasonal reserve reduction of approximately $11 million and stable portfolio risk ratings, that we have anticipated these challenges and are actively working to address their impact on our portfolio. We continue to work collaboratively with our borrowers to maximize shareholder value. Our strategy for resolution remains the same, whether we modify, extend or foreclose, our focus is to maximize shareholder value in the most efficient manner possible given the facts and circumstances presented. From a liquidity perspective, we continue to risk manage from a position of strength.

Our year-end liquidity exceeded $590 million, and for new investments we had substantial liquidity via four main sources. Number one, the A-note market; number two, existing CRE CLO and reinvested capacity in both FL4 and FL5, potentially new public and privacy CRE CLO transactions and our existing secured credit facility. Over the past year, as a testament to the diversity in our funding sources, we have executed on each of the four aforementioned financing options, all while maintaining an industry leading debt cost of funds of 203 basis points over the applicable benchmark rate across our liability structure. Our teams investing and asset management experience benefits from two distinct attributes. Number one, a leadership group with an average of 25 plus years of experience, investing across multiple economic cycles, combined with two full integration into the broader TPG real estate ecosystem, with an oversight of $20 billion of AUM across multiple investment strategies.

Given the disruption in real estate markets being aligned with the leading global alternative asset management firm, combined with tremendous information flow from the broad reaching, real estate equity and credit platform, allows TRTX to prudently navigate the current market. I’m incredibly excited about the prospects for TRTX. We have been front footed in acknowledging the stress in real-estate markets, while positioning ourselves to benefit from an attractive lending environment. This proactive approach will serve our shareholders well as the current cycle evolves. Thank you. Bob, please go ahead.

Bob Foley: Thanks, Doug. Good morning, everyone, and thanks for joining us on this morning’s call, especially those of you with school age children trying to enjoy the school holiday week. First, our operating results. GAAP net income for the fourth quarter was $32.6 million or $0.42 per diluted share, reflecting the benefit of rising benchmark rates on net interest margin, which increased $4.7 million or 16% quarter-over-quarter. Higher benchmark rates and a balance sheet that is 100% rate sensitive, are strong tailwinds for net interest margin and net earnings. Distributable earnings was $23.3 million or $0.30 per share, a quarter-over-quarter increase of 53% due to net interest margin expansion and a decline in loan write-offs in comparison to the prior quarter.

Credit performance will be the key determinant of distributable earnings in future quarters. Our dividend coverage was 1.25x for the quarter and 1.17x for the year. Book value per share increased quarter-over-quarter by $0.20 to $14.48 per share on the strength of a CECL reversal of approximately $11 million, and distributable earnings that outstripped by $0.06 per share, our dividend per share of $0.24. Our CECL reserve declined by approximately $11 million. At quarter end our reserve rate was 395 basis points as compared to 390 basis points for the prior quarter. We continue to thoughtfully utilize the TPG ecosystem, our ample liquidity, our 74% non-mark-to-market financing base and our highly experienced investment to capital markets and asset management teams, to support opportunistic lending and preemptive asset management to drive value creation and earnings for our shareholders.

Regarding liquidity, we have $590.9 million of it at year end, including $231.7 million of cash, $297.2 million of CLO reinvestment cash, plus undrawn capacity under our credit facilities. Two of our three CLO’s are open for reinvestment; FL4 through March of 2023 and FL5 through February of 2024. These term, non-mark-to-market, non-recourse liabilities, with a weighted average credit spread of 180 basis points are immensely valuable to us and supporting new loan investments, optimizing our current financing arrangements and sustaining or boosting investment level ROE. $67.4 million of our year end CLO reinvestment cash has since been utilized across seven different investments. Unfunded commitments under existing loans were $426.1 million or only 7.8% of our total loan commitments, which is comparable to prior quarters.

This low level reflects our historical discipline in targeting bridge and light transitional loans with quick to complete business plans and small proportions of deferred fundings. Regarding credit, rising rates continue to pose a headwind to all property types. A muted pace of return to office remains a sustained challenge to the office sector. Nonetheless, our weighted average risk rating remained unchanged quarter-over-quarter at 3.2 and the dispersion of ratings across our portfolio was largely unchanged. Measured by amortized cost, 75% of our loans were rated three or better, 20% were fours and 5% were fives. Our CECL reserve declined by approximately $11 million or 5%, due primarily to $336.5 million of par repayments, plus the conversion to REO of one office loan, all of which enabled reserve releases.

Our general reserve decreased by $23.2 million due to par loan repayments in the general reserve population and the reclassification of one office loan to the specific reserve. This was offset by the model based impact of higher short and long term interest rates, worsening macro-economic factors and a challenging operating evaluation environment for commercial real estate. Our specific reserve covering four loans increased by $12.2 million due to macro and asset specific factors, and a one loan change in the composition of the specific reserve loan population. The office loan converted to REO in early October was by mid-November sold to an investor at a price roughly equal to its carrying value. We recovered 95% of our UPB as compared to our carrying value net of CECL at the prior quarter end of roughly 85% of UPB.

We provided to the purchaser $59 million of first mortgage financing on market terms, and that loan is term financed on a non-mark-to-market basis. Our new borrower invested $29.3 million of fresh cash equity to acquire the property. Our asset management team delivered an excellent result here after multiple quarters of thoughtful work. Rate caps are another popular topic. We require our borrowers to purchase rate caps, and at quarter end roughly 90% of our loans measured by loan commitment amount at borrower owned rate caps with a weighted average strike rate of 2.71%. By comparison, current terms SOFR is 4.56%. Regarding the loan portfolio for the quarter, we received repayments in full of $294.4 million and a near record $1.3 billion of full repayments for the year, of which 38% were office loans.

That excludes partial repayments of $209.5 million, of which $176.7 related to office loans. As Doug mentioned, year-over-year our office exposure declined by 32% to 29% from 42% of our portfolio. We do believe higher rates and challenging real estate fundamentals are likely to slow repayment speeds in 202. Our $1.7 billion of 2022 investment activity reflects our view since mid-2022, but the lending market is quite attractive, offering lower advance rates €“ excuse me, wider spreads and lower attachment points. For 2023 our investment plans remains opportunistic. We intend to match our investment volumes to loan repayments. We remain laser focused on low cost and non-mark to market non-recourse term funding. At year end 73.5% of our secured financing was non-mark-to-market.

For the full year we arranged $1.8 billion of non-mark-to-market term debt capital, including $1.1 billion of CLO funding via our 5th CLO, $726.3 million of non-CLO term financing, which was a mix of note-on-note syndicated senior loans or A-note financing, and included several new counterparties. We continue to collaborate with TPGs capital markets franchise to mine existing and new capital relationships to form term non-mark-to-market accretive financing. We also added during the year a $250 secured revolving credit facility, which we later upsized to $290 million. Our leverage remains modest. Our total debt to equity ratio was 3.97:1 down from 3.13:1 at the previous quarter end, and we remain in compliance with all of our financial covenants.

With that, we’ll open the floor to questions. Operator?

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Q&A Session

Operator: Thank you. . We have our first question from the line of Stephen Laws with Raymond James. Please go ahead.

Stephen Laws: Yeah hi! Good morning. Doug, maybe start with the four loans that have a specific reserve. Can you can you give us an idea of your current thoughts around resolution, timeline for those and maybe any additional details I think was mentioned in the prepared remarks. There was one new office loan that had a reserve move from general to specific. So some color around that loan as well please.

Doug Bouquard: Absolutely! So right now we’re carefully evaluating the most effective path towards resolution. That may take the form of a loan sale, that could take the form of foreclosing and owning that asset. But generally speaking, we’re going to be thoughtful in terms of maximizing recovery and given our collective view on the fact that the office market should be getting better anytime soon, we expect to be resolving it as quickly as we can while maximizing shareholder value.

Stephen Laws: Great. And you know, maybe shifting to run right EPS Bob. As I think about kind of where we move, you know I think in the Q or in the K it’s a little over $1 million of prepayment incoming Q4. Portfolio is down a touch, but I think in your prepared remarks you mentioned kind of flat outlook as originations match repayments. You know maybe some benefit from increasing rates, but can you maybe give us any other considerations we need to think about as we look at a run rate EPS before any write off or realized losses occur.

Bob Foley: Well Stephen, I think you’ve hit the principle topics. MG&A is pretty level. Clearly higher rates and rising rates are helpful to NIM and we would expect a little more expansion there. I think the volume of one-timers that you referenced is, you know I would say unusual. We typically don’t have a lot of them. We had one loan for the quarter distended, that we paid a little sooner than we expected, but that was only $1.4 million. So I think that what we envision is a pretty stable NIM outlook. The question will be credit, which you alluded to in your comments.

Stephen Laws: Great! Well, I appreciate the comments this morning and congrats on a nice quarter. Obviously, the market was impressed with the results, as was I. Thanks for your time.

Doug Bouquard: Thanks, Stephen.

Bob Foley: Thanks, Stephen. I appreciate it.

Operator: Thank you. We’ll take the next question from the line of Richard Shane with JP Morgan. Please go ahead.

Richard Shane: Thanks everybody for taking the questions. Hey Bob, can you talk a little bit about the mechanics of the general CECL reserve? I know that a lot of its data driven by historical information. I think everybody uses TREP, but would love to think about some of the inputs that could change. Because that is, I assume fairly backward looking and think about some of the macro inputs and overlays you put on top of that, and how we could think about that evolving over the rest of the year.

Bob Foley: Sure. Thanks for the question Rick. It’s a good one. I would start by reminding all of us that CECL which came into effect a little more than three years ago at the beginning of 2020, is intended to cause registrants to record reserves that reflect the expected loss over the life of each loan. So it’s really a prospective view of the world, not an historical one. So while historical data is useful and informative and you’re right, we subscribe to a data service as do many of our public peers that provides historical loss data on more than 125,000 loans extending back to the late 1990s. The real issue or the real important inputs are things like loan-to-value and that service coverage. The amount of equity that a borrower has in a loan and then a number of macro inputs, including short and long term rates, GDP growth, unemployment and so on.