TPG RE Finance Trust - Q2 2024

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the TPG Real Estate Finance Trust Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

Speaker 6

Good morning, and welcome to the 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 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, it's my pleasure to turn the call over to Chief Executive Officer, Doug Bouquard.

Doug Bouquard (CEO)

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 disinflation is underway and more accommodative financial conditions may be just around the corner. Corporate credit spreads remain near the post-GFC tights, 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 into 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 well-known loan 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 a constant in real estate investing. 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's investment approach has remained steadfast, maintained ample levels of liquidity, proactively risk manage our balance sheet, and selectively identify new investment opportunities. Our results demonstrate the benefits of this strategy. Our portfolio is 100% current, we have no five-rated 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, a 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 million multifamily loan two 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 two to one debt-to-equity ratio and are positioned to accretively grow the balance sheet as the opportunity set 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's 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 investing platform provide 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.

Bob Foley (CFO)

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 a 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 1.17 times, and 1.21 times for the first six months of this year. Our CECL reserve declined by $4.5 million to $69.6 million from $74.1 million, or $0.6 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 five-rated loans, nor 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 science is 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 two office loans, one in Atlanta and the other in the Mid-Peninsula submarket of the Bay Area. At quarter end, total office UPB was $587.5 million across six of our 48 loan investments. We had no new loan originations during the quarter, but we did close on July 3rd at $96 million first mortgage loan on a two-property portfolio of leased multifamily, whose closing slid from the last week of June to the first week of July. Our sizable pipeline is populated with quality transactions that hit our strike zone.

Regarding REO, we have five REO properties comprising 5.2% of our total assets, one multifamily property and four 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 four 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 31st. Total leverage declined to 2-to-1 from 2.2-to-1 at March 31st. 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 via 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 improving. 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 three 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 30th, 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 six months of this year.

We maintain an appropriate amount of immediate and near-term liquidity at 10.5% of our total asset base. Cash and near-term liquidity was $389.4 million at June 30th, compared to $370.7 million at March 31st. 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 total only $139.6 million, merely 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 (participant)

Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. If at any time you wish to remove your question from the queue, please press star two. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. Our first question is from Tom Catherwood with BTIG. Please proceed with your question.

Tom Catherwood (Managing Director)

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

Doug Bouquard (CEO)

Yeah, you know, sure, happy to. And, you know, sort of bear in mind that, you know, we as a platform are also a borrower in the CMBS market, so we do share some pretty unique, you know, perspectives. But really what happened in the CMBS market is, you know, you saw, you know, a pretty meaningful spread tightening, you know, pretty much beginning from January up until about, you know, about the month of June. And in the month of June, what you began to see is, you know, 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, you know, 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, you know, more and more activity within our pipeline. And we are beginning to see that, one. And then two, I would say, you know, CMBS does have its limitations in terms of the types of assets it can't finance. You know, we are, you know, fundamentally looking at, you know, primarily bridge and transitional assets. So we sort of have the benefit of both certain assets that perhaps would have gone to CMBS, you know, we can now look at financing them.

And then I would say, secondly, you know, as there is, you know, some amount 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 of the CMBS market. So, so in short, we definitely view this to be a driver of activity going into the second half of the year.

Tom Catherwood (Managing Director)

That's a 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, you know, 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, you know, that has grown in scale?

Doug Bouquard (CEO)

Yeah, I mean, look, I think from a, you know, from a pipeline perspective, you know, we're seeing a tremendous amount of deals right now across really a variety of different property types. You know, from a, you know, from a measurement perspective, you know, we at any time may have up to, you know, 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, you know, fill in for where that, you know, where that gap is. So I would say that there's been a substantial increase, and, you know, really at the lows, which I would say was probably Q4 of last year.

You know, I would say anecdotally, we're probably seeing nearly about a 50% increase in terms of some of the activity based on how we, you know, how we track the pipeline.

Tom Catherwood (Managing Director)

Really helpful. That's it for me. Thanks, everyone.

Doug Bouquard (CEO)

Thank you.

Operator (participant)

As a reminder, to ask a question, please press star one. Our next question is from Stephen Laws with Raymond James.

Stephen Laws (Managing Director)

Hi, good morning.

Doug Bouquard (CEO)

Good morning, Steve.

Stephen Laws (Managing Director)

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

Doug Bouquard (CEO)

Yes, sure. You know, I'll say a few things really about how we're thinking about investing, and quickly as it relates to our repayment pace. You know, first and foremost, what really drives all of our new investment activity is, you know, being highly selective. I, I mentioned in my comments the sort of phrase of there being this, you know, uneven real estate recovery, you know, 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 gonna 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, too, as it relates to, you know, property types specifically, you know, I think you'll still see somewhat of a housing bias coming from us, you know, really across the multifamily space, where we do see, you know, both a good amount of opportunity and dislocation, which for us as a, you know, as a lender, is very attractive. And then I think on your final comment about, you know, repayments, it's a great question. I think that, you know, there are obviously both some micro and macro factors that will weigh on the pace of our repayments. I would say on the micro side, again, it's naturally, you know, of course, very loan by loan.

You know, for example, we had, you know, we had two, you know, pretty substantially sized office loans pay off this past quarter, which, you know, we did expect it to, to pay off, but the exact timing can at times be hard to maybe nail down to the sort of, you know, week or, or even day. But generally speaking, from a repayment perspective, we are starting to see a little bit more of a pickup. 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'd say finally, on the sort of macro point, which we're obviously very, you know, very focused on, and in many ways, this, this will be a much bigger driver, is, you know, if we, if we do sort of encounter easing financial conditions and the front end of the curve does, you know, go lower, I think that will definitely, you know, potentially open up some amount of refinance within our balance sheet. Part of that driven by, you know, borrowers, you know, perhaps once again, able to get, you know, what they would view as attractive financing to continue on their business plan, and they may want to pay our financings off.

So again, it's a mix of really micro and macro, but, we do acknowledge that the, the one overlying factor as we think about new investments, which is pretty unique, is, you know, we've been talking about the sort of pullback of bank lenders for, for many quarters. But we may encounter the first time in sort of recent history where there is a pullback in bank lending, but the demand from, 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 technicality of potentially front-end rates going lower, banks pulling back, and then I think TRTX being well-positioned from a liquidity perspective to be able to take advantage of that, of the potential gap.

Stephen Laws (Managing Director)

Appreciate the comments on that, Doug. And, follow-up question, I wanna kind of touch on the four rated loans. You know, are there any second half events or milestones that would be instrumental as you look at those four loans on whether they move back to three or potentially have internal problems? And then, you know, specifically, any update on the San Antonio loan? I think there was a news article maybe that mentioned it was moving to a foreclosure sale, so curious if there's an update there.

Doug Bouquard (CEO)

Sure. Thanks for your question, Steve. First, the macro, and then we can talk specifically about San Antonio. On the macro front, you know, 4-rated loans are clearly behind their business plan, but their eventual resolution can take a number of paths, and as we've discussed on previous calls, historically, a large proportion of 4-rated loans actually resolve, you know, without incident. With respect to the specific 4-rated loans right now, you know, we're all over each of them. And, you know, 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. You know, there's dispersion within that population.

Some are probably closer to the boundary of a three, and some are probably, you know, 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 two-property multifamily portfolio in San Antonio that is not meeting its original business plan. San Antonio is a, you know, a solid, affordable multifamily market. Having a... You know, Texas is a state in which it's relatively straightforward and quick to foreclose, and it's a good cudgel to use when negotiating with the borrower over terms of a modification.

That's the current state of play. We tolled the sale that was originally posted in July because the borrower took certain steps and actually infused 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 (Managing Director)

Appreciate the color there, Bob. And then one last follow-up. On the REO assets, I know it contributed $0.04 of Distributable Earnings this quarter or in Q2. You know, can you talk about-

Doug Bouquard (CEO)

Right

Stephen Laws (Managing Director)

... maybe which one of those, you know, what are, what are the one or two that are potentially the, 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? You know, similar loans, I'm sure there's a dispersion of performance across those five assets.

Doug Bouquard (CEO)

Yeah. We own five properties, as you and others on the call know. We own one multifamily property. That is a contributor to NOI. We've increased under our ownership, occupancy in that property from the high seventies to the low nineties. So we're pretty pleased with the operational changes that we've been able to effect 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 two properties, both of which are in California, are effectively, you know, break even 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 rebuy analysis suggests that the best thing for shareholders is for us to invest, or to sell.

And as we've stated before, I think a lot of that will become much clearer between now and Thanksgiving.

Stephen Laws (Managing Director)

Fantastic. Appreciate the comments this morning.

Doug Bouquard (CEO)

Yep.

Operator (participant)

As a reminder, if you'd like to ask a question, please press star one. Our next question is from Steve DeLaney with Citizens JMP.

Steve DeLaney (Analyst)

Good morning, Doug and Bob. 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, you know, $4 million-$5 million. Is that—was that due to—simply due to payoffs in the quarter, that caused the CECL reserve to drop?

Doug Bouquard (CEO)

Well, I would say that there were three factors. One, as you point out, is, you know, 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 three factors is, you know, the operating performance of most of our collateral has been pretty solid.

So that's reflected largely in the debt service coverage ratio, which is an important variable in the predictive model itself. Those are the three factors.

Steve DeLaney (Analyst)

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

Doug Bouquard (CEO)

Thanks for your question. Well, first I'll offer an editorial comment, which is that I try to avoid the use of the word build with respect to CECL reserves, because that's exactly what the FASB was seeking to avoid when it 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. You know, we are now investing in a very good credit market as a lender, where we have, you know, much lower entry points per square foot, per unit, per key than we did several years ago. And so 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, you know, between, at the old end, 2018 or 2019, but, well, most of them were originated in 2021 through 2023. You know, we've moved into a new era where arguably the risk profile is higher in place debt yield, 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, you know, loan losses or what people's estimates were, prior to COVID, and draw some inspiration from that.

Steve DeLaney (Analyst)

Thank you. It's a very helpful call. Appreciate the comments.

Doug Bouquard (CEO)

Thank you.

Operator (participant)

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 (CEO)

Yep. I 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 (participant)

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