TPG RE Finance Trust - Earnings Call - Q1 2022

Transcript

Speaker 0

Greetings, and welcome to TPG RE Finance Trust First Quarter twenty twenty two Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow a formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Deborah Ginsberg, Vice President, Secretary and General Counsel.

Thank you, and over to you.

Speaker 1

Good morning, and welcome to TPG Real Estate Finance Trust's conference call for the 2022. I'm joined today by Doug Poucard, Chief Executive Officer Matt Coleman, President Bob Foley, Chief Financial Officer and Peter Smith, Chief Investment Officer. Matt 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 Q and issued a press release 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 Q and 10 ks. We do not undertake any duty to update these statements, and we will also refer to certain non GAAP measures on this call. And for reconciliations, you should refer to the press release and our 10 Q. With that, I'll turn the call over to Matt Coleman, President of TPG Real Estate Finance Trust.

Speaker 2

Thank you, Deborah, and thanks to everyone for joining this morning's call. Before I turn to our results for the first quarter, I want to introduce Doug Bucard, who formally joined us last week as the CEO of TRTX and as a TPG partner. As most of you are aware, prior to joining TPG, Doug spent his entire eighteen year career at Goldman Sachs where he most recently served as a Managing Director and Head of U. Commercial Real Estate Debt in the Global Markets Division. In that role, had oversight of the firm's commercial real estate debt origination activities including securitized lending, balance sheet lending, and commercial real estate warehouse financing as well as commercial real estate securities issuance.

As I mentioned on our last earnings call, we've gotten to know Doug quite well over the last several months, and I couldn't be more pleased to welcome him to TRTX and to TPG. Doug's appointment is an important step for TRTX and the firm, I look forward to partnering with him for many years to come. With that, let me pass it over to Doug for a few remarks.

Speaker 3

Thank you, Matt. I am incredibly excited to join the leadership team here at TRTX and TPG. I'll first start with what human capital is amongst the most important assets of any organization. And despite starting just a few days ago, I've been incredibly impressed with the quality of our people both within TRTX and TPG broadly. As financial markets transition from the era of QE to QT, the investing opportunities set for real estate credit markets will be compelling and our company is well positioned to take advantage of this investing landscape.

Lastly, I look forward to meeting many of you over the coming weeks as I settle into my new role. And with that, I will turn it back to Matt to discuss the first quarter and the broader market environment.

Speaker 2

Thanks, Doug. Turning now to the first quarter, let me begin with a few comments on the macro environment and its impact on TRTX over the quarter. Needless to say, 2022 has gotten off to a complicated start. From the Russian invasion of Ukraine to inflation at forty year highs to rising interest rates and the continuance of a global pandemic, the environment is choppy. We're seeing the effects of this confluence of factors in public equity markets with the Nasdaq down approximately 20% year to date and the S and P five hundred also down double digits.

On the other hand, many real estate asset classes, particularly as reflected in private market valuations remain strong. Multifamily has proven thus far to be a very effective inflation hedge. Rental rates and industrial continue to grow and demand for lab space continues to be robust. And while it's true that new office is winning in certain markets, it's also the case that the country's office recovery has been uneven at best. According to Nacreth, four quarter NOI growth in office is the only negative reading across CRE property types.

As a final complicating overlay, spreads widened significantly in the SAVI and CLO markets, but have been slower to rise in the transitional lending space, although we're starting to see some movement on that front. So how did all of these factors affect TRTX during the first quarter? First, as reflected in our q one originations, we approached this quarter as we do all others from the perspective of being good stewards of investor capital. In light of the geopolitical and market uncertainties that I just highlighted, we invested selectively consistent with our strategic approach to geographies, asset classes, and sponsors that we think are best positioned to succeed. As a percentage of total commitments, slightly more than half of our originations for the quarter were in multifamily and 48.5% were in industrial.

Total new commitments for the quarter were $233,000,000 reflecting a cautious approach in light of the environment. Our repayments in the first quarter were also slower than forecasted, which resulted in modest net asset growth. As we've started to see the opportunity to earn more spread, we've picked up the pace a bit with five new loans closed or in the process of closing since quarter end, representing total commitments of just over $300,000,000 This prudent approach has resulted in available liquidity of $384,200,000 which positions TRTX well to take advantage of evolving market conditions and opportunities. With respect to the portfolio, interest collections for the quarter were again in excess of 99%, reflecting strong performance and resilience with our Southern California retail property remaining our only non payer. In addition, we closed on the sale of the North parcel of our Las Vegas land position for a purchase price of $75,000,000 versus an allocated carrying value of 60,600,000.0.

Together with the previous sale of the South parcel, those sales generated a total gain of $16,300,000 versus our original loan basis of 112,000,000. This resolution demonstrates the strength of our loan structures and asset management capabilities. While we generally expect our assets to perform as underwritten, we often structure loans with interim milestones to keep business plans on track. In most cases, we can work with borrowers to adjust when things don't go as planned. But in limited circumstances such as this, we're well equipped to act when necessary to preserve value.

Through an efficient resolution with our underlying borrower and proactive asset management, we're able to identify the optimal buyers for each individual parcel and transact quickly. As I've mentioned on prior calls, we were encouraged by the strength of the Vegas market and that thesis proved out. Turning to the broader portfolio, we downgraded the risk ratings of eight office loans this quarter reflect reflecting the uneven office recovery discussed earlier, together with widening cap rates and delayed business plans across the office sector. Despite the downgrades, which we view as prudent under the circumstances, all of our office loans continue to perform. As I mentioned, active asset management is a key pillar of our organization and these downgrades reflect our increased attention to these loans as we work through slowing business plans.

While none of us can be clairvoyant about the pace of interest rate increases, where inflation is headed, and the outcome of certain geopolitical events, I have full confidence that TRT is well positioned for what lies ahead. Under Doug's leadership, with the intellectual capital that comes from being part of TPG and with the substantial liquidity that we have available to deploy into the most interesting and strategic transitional lending opportunities, TRTX is well positioned to continue growing earnings and delivering attractive shareholder returns. With that, I'll hand it over to Bob to cover our q one results in greater detail.

Speaker 3

Thank you, Matt. Good morning, everyone. It's now my turn to welcome Doug to the team. I've known Doug for many years and all of us here are thrilled that the firm and the Board of Directors selected him, that Doug chose to join the TRTX team and that we're working together. Yesterday, we reported earnings for the quarter ended March 31 as follows: GAAP net income of $23,800,000 versus $44,900,000 in the prior quarter Net income attributable to common stockholders of $20,400,000 or $0.25 per diluted share, a decrease of 51% versus the prior quarter.

Distributable earnings of $26,600,000 or $0.33 per diluted share versus $18,500,000 or $0.23 per diluted share in the fourth quarter. For all three of those earnings measures, the quarter over quarter difference was due primarily to the absence in the first quarter of the $15,800,000 gain from our fourth quarter REO sale and a write off of a portion of a defaulted retail loan and an increase in the first quarter of $4,900,000 in the CECL reserve. Distributable earnings from our basic transitional lending business were virtually unchanged quarter over quarter, dollars 26,600,000.0 in the first quarter of this year versus $26,700,000 in the prior quarter. Once again, distributable earnings comfortably covered our quarterly dividend of $0.24 per common share. Net interest margin increased slightly despite a one time expense of approximately $1,100,000 of deferred financing costs related to loans previously financed on several of our secured credit facilities that were contributed in February 2022 into TRTX 2022 FL-five, our latest CRE CLO.

Drivers of net interest margin included a quarter over quarter increase in our weighted average loan coupon to 4.59% from 4.49%, a decline in the weighted average rate floor in our loan portfolio to 105 from 110 basis points due to loan repayments and the earning of loans originated in the preceding quarter. Net interest margin did benefit from the steep rise in rates during the final third of the first quarter. Book value per common share increased quarter over quarter by $04 per share to $16.41 from $16.37 due primarily to net income exceeding dividends paid. Our current quarterly dividend of $0.24 per common share produces annualized yields of 5.9% to book value and 8.8% to yesterday's closing stock price. For the quarter, our CECL reserve increased by $4,900,000 due to our adoption of a more conservative macroeconomic forecast for modeling our expected losses, heightened concerns about the office sector nationally spurred by a slower than expected return to office and some business plan slowdowns experienced by some of our office loans.

More on this topic shortly. Our CECL reserve rate measured as a percentage of total commitments was 91 basis points compared to 85 basis points for the preceding quarter. The right side of our balance sheet is integral to our growth, profitability and risk mitigation. Our work in the first quarter sought to extend duration, maintain a high proportion of non mark to market liabilities and preserve low cost financing. At quarter end, our liabilities were 72.5% non mark to market, within our usual range of 70% to 80%.

Consequently, we continue to streamline our portfolio of secured credit facilities by downsizing two, but retaining accordion options on both, terminating one with zero usage and extending the maturity of several others. Over half our liabilities have maturity dates beyond the typical maturity of our loans. During the quarter, we closed FL5, a $1,100,000,000 managed CRE CLO with a two year reinvestment period, an advance rate of 84.4% and a weighted average interest rate at issuance compounded SOFR plus two zero two basis points. We redeemed FL2, whose reinvestment period ended in the 2019 and via loan repayments had amortized to an advanced rate of 74.5% versus nearly 80% at issuance. This redemption was funded with proceeds from FL-five plus existing secured credit facilities.

And we closed a new $250,000,000 recourse revolving secured credit facility to fund new and existing loans for up to one hundred and eighty days at a running cost of term SOFR plus 200 basis points. And finally, through yesterday, we'd extended the maturity of three secured credit agreements. On April 4, we closed on the sale of the second of two land parcels on the Las Vegas Strip that we acquired via deed in lieu of foreclosure in December 2020. We sold a 10 acre parcel for $75,000,000 or $7,500,000 per acre, realized a gain for book and tax purposes of $13,300,000 and we'll utilize $13,300,000 of our $187,600,000 of capital loss carry forwards to retain all of that gain, thus boosting our book value by approximately $0.17 per share. The economic recap for the entire 27 acres that secured our initial loan, a whole period of fifteen months, an aggregate sales price of $130,000,000 a net gain of $29,100,000 measured against our written down carrying value of $99,200,000 and a net gain of $16,300,000 measured against our original loan amount of 112,000,000 Regarding portfolio construction and credit, our portfolio reflects our primary investment themes, which are affordable multifamily, life sciences and industrial.

Year over year, our multifamily exposure grew by 79.5% to 30.7% of our portfolio. Life Sciences grew by over 200 to 8.8% of our portfolio and Office declined by 24.3% to 39.6% of our portfolio. At quarter end, our loan portfolio weighted average as is LTV ratio was 67.2% compared to 67.1 for the prior quarter. As discussed on prior calls, our LTV has remained consistent since 2018. Risk ratings increased slightly quarter over quarter to 3.1 from three point zero, due almost entirely to our decision to downgrade the risk ratings of seven office loans to four from three and one office loan from two to three.

This precautionary step is consistent with our prior practice. In the 2019, we immediately downgraded a loan secured by a rent stabilized apartment complex in New York City when the state tightened its rent stabilization statute. And in the 2020, you'll recall we downgraded all of our loans secured by operating hotels as the lodging sector hunkered down to weather the COVID storm. All of our office loans are performing, but we are mindful of the headwinds facing the office sector nationally caused by slowdowns in business plan execution, the slower than expected to return to the office by American workers, the capital investment that may be needed to address COVID, carbon zero and other ESG related regulations and the impact of rising rates on the ability of office owners to sell or refinance their properties. Our asset management team actively monitors general conditions in the office markets and each of our office loans to encourage their timely repayment.

Regarding interest rates, higher rates are good for floating rate lenders like TRTX. Short term rates rose materially during the first quarter and continued their surge through April. Yesterday term SOFR was approximately 81 basis points and one month LIBOR was 80 basis points. We're moving steadily toward positive interest rate sensitivity demonstrated by the decline of our weighted average rate floor during the quarter to 105 basis points. At quarter end, the share of our loan portfolio with rate floors less than 100 basis points was 42.5% and the share with rate floors of at least 200 basis points was 18.9%.

The race among rising rates, the origination of new loans with new rate floors and the repayment of existing loans with high rate floors will determine the timing and magnitude of improving net interest margin. As rates rise, so does the economic incentive for borrowers to repay these high coupon loans. Based on our current forecast, we expect our net interest margin will expand

Speaker 0

toward

Speaker 3

the end of this year or very early next year. We'll have better visibility by the third quarter of this year when a substantial portion of this year's loan repayments are expected to occur. Our smooth transition to SOFR from LIBOR continues. At quarter end, 61% of our liabilities and 4% of our assets were SOFR based. Our liabilities will continue to transition during 2022 at a pace largely of our own choosing.

The share of our assets pegged to SOFR will grow as we originate more SOFR based loans and as we elect to change the benchmark rate of our existing loans to SOFR from LIBOR, the timing of which we also control. All of our 2022 loan originations are SOFR based and we don't expect the transition will have a material impact on our operating results. Finally, with regard to liquidity, leverage and growth, we have substantial investment capacity for growth and ample liquidity for offense and defense if required. At quarter end, we held available cash of $3,500 and $400,000 available undrawn borrowing capacity of 32,300,000 and unpledged loan investments in real estate of 74,300,000.0 Our debt to equity ratio was 2.5 to one. Our target remains 3.75 to one.

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

Speaker 0

Thank The first question comes from the line of Rick Shane with JPMorgan. Please go ahead.

Speaker 4

Hey, guys. Good morning. Thanks for taking the question. Given the environment, can you just talk a little bit about the structural protections that you build into your loans related to both higher interest rates, but also to execution risk related to supply chain delays, prolonged construction and material inflation?

Speaker 2

Sure. Peter, do you want to take that?

Speaker 5

Yeah, I can I'll jump in on that. So when yeah, when we're evaluating we look at obviously we're aware that there's been a lot of issues with respect to people getting supplies and actually and labor and whatnot. For the most part, you look at sort of our moderate lift multifamily workforce housing deals that we've done and loans that we've closed, We're seeing a little bit of a slowdown and really on deliveries of mostly appliances and whatnot. And that really sort of moderates the pace of renovations. But what's interesting is a lot of these moderations and the slowdown in these renovating these units where you renovate the units and then pop the rents by a couple of $100 per month.

We're seeing the rent gains. You're getting a lot of rent gains not doing those renovations. So we really haven't been terribly impacted by those really supply chain issues for the most part, maybe slowed down a little bit on the margin, but nothing sort of material from our end on that.

Speaker 3

The other thing that I

Speaker 2

would add, Rick, is that we haven't done straight construction loans post and during COVID. And I and I think, generally, we've been lending on lighter transitional renovation plans as opposed to heavier.

Speaker 5

Yes. Also borrowers have been very quick to sort of reposition. For instance, we're looking at signing up a relatively straightforward, I think it's 75% LTC loan on a light renovation and borrower is already redirecting. He owns four other assets in the market. He's directing a truckload of appliances from some of the assets he owns in New Jersey.

So he's able to secure them and move them down and putting them in a warehouse down in Texas where he will end up using those over time. And then with respect to rate increases, think it was the other part of your question. We actually do require rate caps. They've gotten a lot more expensive over the last two months. But generally, almost everyone I believe every one of our loans has a rate cap of a certain amount.

Certain borrowers have chosen lower rate caps and actually have profited quite well on it. But generally, we're looking at having about requiring borrowers rate caps in the 2.5% to 3% strike price and have them buy that for one to three year terms.

Speaker 4

And I was that was the second part of my question. The rate caps, are the rate caps on the original term, are they on a fully extended basis?

Speaker 5

They're it's generally a combination. For the most part, it's it's, you know, we're getting for two years, and then, you know, I think the average life of our loan is twenty seven months or something like that. It could be off. Bob knows that number. But, generally, they're they're buying for the most part in twenty four months.

So they'll buy a two year rate cap, And that cost has really tripled over the last thirty days or so, forty five days. Think a three Yeah. Last, I think

Speaker 4

Sure. I'm sorry. Was going say, Doug. Nice to meet you on the phone.

Speaker 3

Pleasure meeting you as well, Rick.

Speaker 0

Thank you. The next question comes from the line of Eric Hagen with BTIG. Please go ahead.

Speaker 6

Hey, thanks. Good morning and nice to meet you, Doug. Maybe a couple from me. In the multifamily portfolio, can you share expectations for rental rate increases that sponsors expect to pass along to renters and how you expect cap rates to maybe evolve as the Fed raises rates? And then in the office portfolio where you guys noted some business plans might be changing or adjusting, can you talk about how that changes the pace of funding commitments going forward?

Thanks.

Speaker 2

Sure. Why don't why don't I just start with some color on on the on the multifamily question? I mean, we we've seen real rental rate run-in in many markets already, and that that's been great for many of the business plans that we've that we've underwritten and for our borrowers' success for our our COVID and post COVID vintage loans. You know, at this point, when when we're evaluating a multifamily business plan, particularly when that involves light right. Light renovations or mark to market rental increases, we're we're looking at a variety of factors, as you know.

We we undertake a rigorous market analysis where we're looking at demographics. We're looking at educational trends. We're looking at affordability. We're looking at rent versus own analysis. It it's very hard to generalize just because you've you've seen such a a wide variety of of differences across the country.

But but in general, as you know, the the the rental rate increases have been have been strong and broad based. There are obviously markets in in Florida where we've seen, you know, 40% increases in rents, over a twelve month period. We're that's that's not anything close to what we're underwriting or what our borrowers are are required to underwrite to make these business plans work. But in general, we're we're continuing to see strong strong rental rate increases. Affordability is is, of course, a a significant factor.

Why don't why don't I turn it over to Bob to talk about the capital deployment as it relates to slowing business plans in the office portfolio?

Speaker 3

Sure. Eric, a good question with respect to unfunded commitments, which at quarter end stood around $440,000,000 or so. Interestingly, an increasing share of our unfunded commitments relate to our lending initiative in life sciences, a sector in which we've been active since 2015, 2016. Those transactions typically involve fairly substantial conversions of existing properties. We've got a theme there that we'd be happy to discuss separately.

But we're generally, as Matt said earlier, not doing ground up construction. So the factors that drive the pace at which dollars are infused into a Life Sciences transaction are decidedly well, they are the same, but the dynamics of the market are very different in Life Sciences than they are in Office. Generally speaking, in our office portfolio, the unfunded commitment dollars relate to what we call good news money, which are TI expenditures and leasing commissions. Those are typically shared between us and our borrower in proportion to our advance rate against the loan as a whole, which is typically in the 65% to 70% range. So those dollars are typically funded only when a qualifying lease that is a lease that meets our minimum leasing guidelines and has been consented to by us is signed.

The pace of those fundings during COVID has slowed, which is to be expected. And as different markets begin to rebound at different paces, we expect we may see some additional increases in the future. But right now, it has been pretty slow and we commented earlier on our liquidity position, is quite strong. And we typically when we do make a deferred funding, we typically finance a portion of that with one of our lenders. So that we'd be funding the equity component of our portion of the total draw, our lender would fund the other portion and then our borrower would fund the last 25% to 30%.

Hope that answers your question.

Speaker 6

That's very helpful color. Thank you guys very much. One follow-up on the multifamily portfolio. Is it fair to think that most of the loans can get a takeout with an agency loan for permanent financing? How does it qualify there?

Speaker 2

Peter, do you want to take that?

Speaker 5

Yes. We in all of our deals, run a refinance analysis. And we actually assume a couple of different ones and really current market conditions respect to rating with the with respect to the agencies, you know, the Fannie, Freddie, and whatnot. So we look at it a couple of way, and then we also usually look at really another way of, you know, con conduit. So, usually, you have two or three refinance analysis.

I would generally say yes, but not every one of them. It depends on what we're using going forward with respect to DSCR and then projected interest rates. But for the most part, pretty yes.

Speaker 2

Thank you, guys, very much. I appreciate you.

Speaker 0

Thank you. Ladies and gentlemen, we have reached the end of question and answer session. And I would like to turn the call back to Matt Coleman, President for closing remarks. Thank you.

Speaker 2

Thank you. As you heard this morning, we're proud of the patience and prudence that characterized Q1 for TRTX. We look forward to navigating the ensuing quarters from a position of strength with substantial dry powder to take advantage of evolving markets. We look forward to speaking with you again on next quarter's call. Thank you.

Speaker 0

Thank you. This concludes today's conference. You may disconnect your lines

Speaker 4

at this time. Thank you for your participation.