Earnings Call Transcript - TRTX Q2 2024

Operator, Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to TPG Real Estate Finance Trust Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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.

Unidentified Company Representative, Unidentified Company Representative

Good morning and welcome to TPG Real Estate Finance Trust earnings call for the second quarter of 2024. We are joined today by Doug Bouquard, Chief Executive Officer; and Bob Foley, Chief Financial Officer. Doug and Bob will share some comments about the quarter and then we will open the floor for questions. Yesterday evening, the company filed its Form 10-Q and issued a press release and earnings supplemental with a presentation of operating results, all of which are available on the company’s website in the Investor Relations section. As a reminder, today’s call is being recorded and may include forward-looking statements which are uncertain and outside of the company’s control. Actual results may differ materially. For a discussion of risks that could affect results, please see the Risk Factor section of the Company's most recent Form 10-K. The Company does not undertake any duty to update these statements, and today’s call participants will refer to certain non-GAAP measures, and for reconciliations you should refer 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 US economy and financial markets have continued to exhibit resiliency as the soft landing narrative gains momentum. Recent CPI data suggests that inflation is underway and more accommodative financial conditions may be just around the corner. Corporate credit spreads remain near the post-GFC highs, and the securitized debt markets have been 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 remind 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 continues 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 are continuing to pivot away from direct lending and toward providing one-on-one capital. Lastly, elevated front-end interest rates continue to put pressure on certain real estate capital structures. We are at a point in the cycle where dispersion and idiosyncratic outcomes will remain constant within real estate investment. Asset, property type, market level, and capital markets intelligence are 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, maintaining ample levels of liquidity, proactively risk-managing our balance sheet, and selectively identifying new investment opportunities. Our results demonstrate the benefits of this strategy. Our portfolio is 100% current. We have no defaulted 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 and robust liquidity position, along with 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, more than 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 the quarter ended. With the softening in CMBS spreads over the past few weeks, we expect borrower demand for floating rate loans to pivot from CMBS to other lending channels, including TRTX and the broader non-bank lending market. With respect to our balance sheet, we continue to maintain robust liquidity with over $389 million of cash and undrawn credit capacity from our secured lenders. We finished the quarter with a 2:1 debt-to-equity ratio and are positioned to accretively grow the balance sheet and the opportunities that evolve. 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, having a solid balance sheet, ample liquidity, and a best-in-class global real estate investment platform provides the foundation on which to drive shareholder value over the long term. With that, I will turn it over to Bob for a more detailed summary of our quarterly results.

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 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 $0.06 per share. This decline was due primarily to solid collateral operating performance and a quarter-over-quarter net decline in UPB of $168 million. All of our loans were current. We had no defaulted loans specifically identified, 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, a $0.06 per share reduction in our CECL reserve; and third, a $0.39 per share decline due to the delivery on May 8 of 2.6 million common shares of TRTX relating to a warrant exercise. No warrants remain outstanding. Regarding our loan investment portfolio, multifamily now represents 52.5% of our loan portfolio. Office has declined 73% over the past 10 quarters to 18.4%. Life Sciences 12.1%, Hotels 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-City 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 3 at a $96 million first mortgage loan on a two-property portfolio of leased multifamily, whose closing split from the last week of June to the first week of July. Our sizable pipeline is populated with quality transactions that fit our investment criteria. 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 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 Note 4 of our financial statements for a snapshot of our REO portfolio. Regarding credit, our weighted average risk rating was unchanged at 3.0. All of our loans were current; refer to Page 53 of our 10-Q for more detail. Regarding liabilities and capital base, the share of non-mark-to-market, non-recourse term financing increased at quarter-end to 78.7% from 77.1% at March 31. Total leverage declined to 2:1 from 2.2:1 at March 31. We have $4.1 billion of total financing capacity across 11 different arrangements. In June, we opted to terminate rather than renew a $500 million secured credit facility with Morgan Stanley due to non-use. We repaid $1.8 million of borrowings upon termination. Liquidity and pricing in the market continue to improve for financing provided to non-direct lending from large and mid-sized banks. Combined with unchanged to slightly wider loan spreads on new loan investments, our ROEs are stable to improve. We completed in April, the reinvestment of the final $51 million of cash in our FL5 CLO. The reinvestment windows are now closed for all 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 one-on-one note market continues to hold greater appeal to us due to more favorable structures and lending terms. We were compliant with all of our financial covenants at June 30, 2024. We repurchased no shares during the second quarter under our share repurchase program, largely because our share price appreciated by 11.9% during the quarter. TRTX share price appreciation was 41.2% for the first six months of this year. We maintain an appropriate amount of intermediate, immediate, and near-term liquidity at 10.5% of our total asset base. Cash and near-term liquidity were $389.4 million at June 30, compared to $370.7 million at March 31, comprised of $244.2 million of cash in excess of our covenant requirements and $127.7 million of undrawn capacity under our secured credit agreements. During the quarter, we funded $18.1 million of commitments under existing loans. At quarter-end, our deferred funding obligations under existing loan agreements totaled only $139.6 million, nearly 4.2% of our total loan commitments and less than half of our current liquidity. In summary, the second quarter was characterized by strong operating performance, solid credit, further optimization of our liability structure, and significant liquidity to support opportunistic capital allocation. And with that, we'll open the floor to questions.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Tom Catherwood with BTIG. Please proceed with your question.

Tom Catherwood, Analyst

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

Doug Bouquard, CEO

Yes. Sure. Happy to. And bear in mind that we, as a platform, are also borrowers in the CMBS market. So we do share some unique perspectives. But really what happened in the CMBS market is if you saw a pretty meaningful spread tightening, pretty much beginning from January up until about the month of June. And in the month of June, what you began to see is spreads widen. I think really as a function of too much supply in the market. So there was definitely a period of time during Q2 where more of the floating rate market share was essentially taken by the CMBS market. We do expect that given the recent widening, it could drive more activity in our pipeline. We are beginning to see that. And I would say, CMBS does have its limitations in terms of the types of assets that get financed. We are fundamentally looking at primarily transitional assets. So we have the benefit of certain assets that might have gone to CMBS, and we can now finance them. Moreover, as there is some recovery within the real estate market, we're seeing borrowers beginning to think through value-add business plans, which require floating rate financing that can really only be obtained outside the CMBS market. So in short, we definitely see this as a driver of activity going into the second half of the year.

Tom Catherwood, Analyst

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

Doug Bouquard, CEO

Yes. I mean, look, we're seeing a tremendous amount of deals right now across really a variety of different property types. From a measurement perspective, we may have up to 60 to 70 deals within our pipeline at any time. Recently, there's been an increase, largely driven by the fact that you're seeing CMBS pulling back. So I would say that there has been a substantial increase. From the lows, which I would say were probably Q4 of last year, I would estimate there’s nearly about a 50% increase in terms of some of the activity based on how we track the pipeline.

Tom Catherwood, Analyst

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

Doug Bouquard, CEO

Thank you.

Operator, Operator

Our next question is from Stephen Laws with Raymond James.

Stephen Laws, Analyst

Hi. Good morning.

Doug Bouquard, CEO

Good morning, Stephen.

Stephen Laws, Analyst

Good morning, Doug. Following up on the origination question, can you maybe talk about how your appetite for new investments balances against your expected repayments in the second half of the year? Is the portfolio size going to increase over the back half, stay the same? Or do you expect some additional runoff here in Q3?

Doug Bouquard, CEO

Yeah. Sure. I'll say things really about how we're thinking about investing and how it relates to our repayment pace. First and foremost, what really drives all of our new investment activity is being highly selective. I mentioned in my comments that there's an uneven real estate recovery littered with idiosyncratic outcomes. We're looking across the landscape, acknowledging that it’s not going to just bounce back uniformly across property types. It's a very patient approach. At the top of the list is remaining selective. As it relates to property type specifically, we expect to see some housing bias coming from us, particularly across the multifamily space where we see both a considerable amount of opportunity and dislocation, which is very attractive for us as a lender. Regarding repayments, some micro and macro factors will weigh on the pace of our repayments. Micro factors can be very loan-by-loan. For example, we had two substantial office loans that paid off this past quarter, which we expected, but the exact timing can sometimes be uncertain. We are starting to see a bit of a pickup in repayments, particularly in multifamily as capital markets loosen up. The macro point we're watching closely is if we encounter easing financial conditions, it could motivate borrowers to seek attractive financing options. Therefore, it’s a mix of both micro and macro factors, but we believe we're well-positioned given the ongoing pullback of bank lenders and potential demand for transitional assets.

Stephen Laws, Analyst

I appreciate the comments on that, Doug. A follow-up question, I wanted to kind of touch on the four-rated loans. Are there any second half events or milestones that are instrumental as you look at those four loans and whether they move back to three or potentially have internal problems? Specifically, any update on the San Antonio loan? I think there was a news article that mentioned that was moving to a foreclosure sale, so I'm curious if there's an update there.

Bob Foley, CFO

Sure. Thanks for your question, Stephen. First, the macro, and then we can discuss specifically about San Antonio. On the macro front, four-rated loans are clearly behind their business plan, but their eventual resolution could take a number of paths. Historically, a large proportion of four-rated loans resolve without incident. Currently, we are closely monitoring each of these loans, working with borrowers to ensure that they're prepared to commit the necessary capital to bring those loans to eventual sale or refinancing. There is dispersion within that population; some loans are closer to reverting to a three rating, while others might be facing more challenges. The post-Labor Day season will be essential as we approach the election in terms of how these situations unfold. Regarding San Antonio, several reports indicated 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 solid, affordable multifamily market. Texas is relatively straightforward and quick for foreclosure processes, which allows us to negotiate effectively with the borrower. We postponed the sale originally scheduled for July because the borrower took action and infused more capital into the transaction. This story will continue to develop over the next couple of months.

Stephen Laws, Analyst

I appreciate the insight, Bob. One last follow-up. Regarding the REO assets, I understand it contributed $0.04 to distributable earnings this quarter in Q2. Can you discuss which of those assets are the one or two that could be the biggest drags on earnings? If you could free up that capital to be recycled, it could significantly boost earnings. I'm sure there are variations in performance across those five assets.

Bob Foley, CFO

Yeah. We own five properties, as you and others on the call know. We own one multifamily property that contributes to NOI. We've increased occupancy in that property from the high 70s to the low 90s. We're pleased with the operational changes we've been able to make, and the market seems to be responding. Our office properties in Houston and New York are also contributors. The other two properties, both in California, are effectively breakeven right now. Those are the properties we’re focused on evaluating alternative business plans for, assessing whether additional capital will be required, and whether our re-evaluation suggests it’s better for shareholders to invest or sell. Much of this should become clearer between now and Thanksgiving.

Steve Delaney, Analyst

Good morning, Doug and Bob, congratulations on a very clean quarter. I expect we won't see many quite as clean over the next couple of weeks. Nice job. I wanted to ask about the CECL reserve which came down $4 million to $5 million. Was that due simply to payoffs in the quarter that caused this reserve to drop?

Bob Foley, CFO

Well, I would say there are three factors. One, as you point out, is we did have a reduction in total loan UPB, which is subject to the CECL estimate process. The second factor is the macroeconomic assumptions that drive the Monte Carlo model that develops the estimates for our general reserve. Those assumptions were, on average, a little bit better than last quarter, especially concerning rates and a slowdown in the pace of property value depreciation. The third and probably most important factor is the operating performance of most of our collateral has been solid, reflected largely in the debt service coverage ratio, which is a crucial variable in the predictive model.

Steve Delaney, Analyst

Got it. As the portfolio starts to rebuild, obviously, you've got your big multifamily loan in July. We're projecting some net portfolio growth. Given your low leverage, that seems reasonable in an improving market opportunity. How should we think about building the general reserve? I mean, you're roughly at 200 basis points now, but can we build it to maybe 150? Any thoughts on the range if we were modeling out over the next year or two how much general CECL build we should consider?

Doug Bouquard, CEO

Thanks for your question. First, I'll offer an editorial comment, which is that I try to avoid the use of the word 'build' concerning CECL reserves because that's exactly what FASB sought to avoid when they established this new pronouncement back in early 2020. The purpose of CECL is to develop a forecast of expected losses over the life of the loan. We are now investing in a very favorable credit market as a lender, with lower entry points per square foot, per unit, and per key than we did several years ago. These are all important inputs into the predictive model we utilize. The current rate reflects loans that were originated between the end of 2018 and 2019, with most originated from 2021 to 2023. We have moved into a new era where the risk profile comes with in-place debt yields, lower LTV, and a lower absolute dollar basis per unit of real estate, all else being equal. I suggest examining loan losses or previous estimates before COVID to gain some insights.

Steve Delaney, Analyst

Thank you. That's very helpful color. I appreciate the comments.

Doug Bouquard, CEO

Thank you.

Operator, Operator

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

Doug Bouquard, CEO

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, Operator

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