Earnings Call Transcript - TRTX Q1 2024

Operator, Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the TPG Real Estate Finance Trust First Quarter 2024 Earnings Conference Call. Please note, this conference is being recorded. It is now my pleasure to turn the call over to the company. Thank you. You may begin.

Unknown Executive, Executive

Good morning, and welcome to TPG RE Finance Trust Conference Call for the first 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 the 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 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 Form 10-Q and Form 10-K. The company does not undertake any duty to update these statements, and today's call participants will refer to certain non-GAAP measures and for reconciliations, you should refer to the press release and the Form 10-Q. At this time, I'll turn the call over to Doug Bouquard, Chief Executive Officer. Doug?

Doug Bouquard, CEO

Thank you, Chris. Good morning, and thank you for joining the call. Since the beginning of the year, the economy and labor markets continue to be remarkably resilient across the U.S. The market remains highly confident in a soft landing for the U.S. economy, and global demand for risk assets remains strong. More recently, however, inflation has proved challenging to tame, and the interest rate market has adjusted its expectations for rate cuts in 2024 over the past few weeks. Further, the 10-year treasury yield has moved nearly 80 basis points during the first four months of the year and is now approaching 4.7%. Within broad credit markets, corporate credit spreads are at multiyear tights, while real estate credit spreads have rallied in certain areas, but do continue to underperform on a relative basis. Once again, this combination of factors provides mixed signals to real estate investors. On one hand, broad market demand for risk assets, a strong economy, and low unemployment should provide tailwinds for real estate valuation. And we do see these trends flowing through in our portfolio. On the other hand, a volatile and elevated interest rate environment tends to reduce transaction activity, put pressure on values, and increase the financial burden on borrowers. This uncertainty is compounded by the shifts we are seeing within the real estate credit landscape from a lending perspective. Banks continue to retreat from direct lending and pivot their attention to lower-risk loan financing, which does benefit TRTX by providing attractive funding sources for its loan portfolio and new originations. We continue to invest TRTX's balance sheet with these competing forces in mind, and our quarterly results reflect our strategic position. During the first quarter of the year, our approach to capital deployment and risk management remained consistent with prior quarters. Given the market backdrop, we continue to focus on: one, maintaining elevated levels of liquidity; two, proactively risk managing our investment portfolio; and three, continuing to position our balance sheet to be able to take advantage of the dislocation in lending markets in 2024 and beyond. Over the past quarter, TRTX's performance reflects both the dedicated focus of our asset management team and the benefits of TPG's broad global investment platform. Our loan portfolio is 100% performing, and both our CECL Reserve and risk ratings reflect very modest change over the past quarter. From a property type perspective, 50% of our loan portfolio is multifamily. Despite the pressures on values within the multifamily sector, we continue to see ample liquidity for both debt and equity transactions. While we acknowledge the Fed signaling to slow rate cuts may put pressure on both near-term values and borrowing costs, we remain confident in the long-term underlying fundamentals of the housing sector broadly. In terms of new investments during the quarter, we originated 3 senior mortgage loans totaling $116 million, 100% of which are secured by multifamily properties. We continue to prefer lending in this sector given the downside protections available in today's market environment. From a liquidity and leverage perspective, we ended the quarter with $370 million of liquidity across both cash and other available liquidity channels and a debt-to-equity ratio of 2.21. While the discount to book value at our current share price has compressed since we last spoke, we continue to believe that this discount is significant and that our shares offer a compelling value proposition at today's price. To that end, on April 25, our Board of Directors approved a share repurchase plan of up to $25 million, demonstrating the Board and management's confidence in the value of TRTX shares. In summary, the past quarter represented an important turning point for TRTX as we begin to deploy capital with a slightly more offensive bet. The resources and deep experience of TPG's real estate debt and equity investment platform grant us unique insights into valuation shifts and capital flows across the real estate landscape. While we acknowledge elevated borrowing costs may increase financial stress on our borrowers, we remain confident in our ability to navigate the ever-evolving real estate credit landscape and are pleased with how our company is positioned to create long-term shareholder value. With that, I will turn it over to Bob for a more detailed summary of this quarter's performance.

Robert Foley, CFO

Thanks, Doug. Good morning, everyone, and thank you for joining us. Our first quarter results reflect the benefit of a 100% performing loan portfolio, a further reduction in interest expense due to continued optimization of our liability structure, including the reduction of interest expense quarter-over-quarter of $7.4 million or $0.10 per share and nearly full deployment of approximately $247.2 million of reinvestment cash in our FL5 CRE CLO. For the quarter, GAAP net income attributable to common shareholders was $13.1 million as compared to $2.6 million for the preceding quarter. Net interest margin for our loan portfolio was $26.8 million versus $21.3 million in the prior quarter, an increase of $5.5 million or $0.07 per common share due to further optimization of our liability structure and the absence of higher cost financing for nonperforming loans, of which we have none. Our weighted average credit spread and borrowings declined quarter-over-quarter to 195 basis points from 204 basis points. Distributable earnings were $23.3 million or $0.30 per share. Coverage in the quarter for our $0.24 dividend was 1.25 times. Distributable earnings before realized credit losses was $23.3 million or $0.30 per share versus $24.4 million or $0.31 per share in the prior quarter due to an improvement in net interest margin, offset by a reduction in noncash credit loss expense. Our CECL Reserve increased slightly to $74.1 million from $69.8 million due primarily to worsening macroeconomic conditions and generic loan default loss data embedded in the TREP database and model we use to forecast our general CECL loan loss reserve. We had no 5-rated loans, no specifically identified loans, thus no specific CECL loan loss reserve at quarter end. Our CECL reserve was 210 basis points versus 190 basis points in the prior quarter. Book value per share is $11.81 as compared to $11.86 last quarter due primarily to the slight increase in our CECL reserve. Multifamily now represents 50% of our loan portfolio. Office has declined 68% over the past 9 quarters to 20.4%. Life Sciences is 11.4%, hotel is 9.9%, and no other property type comprises more than 3.3% of our portfolio. Regarding REO, we have 5 REO properties, 1 multifamily property and 4 office properties with a total carrying value of $192.4 million and a blended current annualized yield on cost of 6%. REO represents a mere 5% of our total assets. Using the substantial resources of TPG Real Estate, we made significant progress during the quarter in advancing value creation and realization strategies for each REO investment. Regarding our multifamily property in suburban Chicago, we've already improved leased occupancy by more than 10 points to 93%. Refer to footnote 4 of our financial statements for a snapshot of our REO portfolio. Regarding credit, our weighted average risk ratings were unchanged at 3.0. All of our loans were performing. We had a small number of changes in risk ratings during the first quarter. Refer to Page 52 of our Form 10-Q for more detail. Regarding liabilities and our capital base, we remain focused on maintaining high levels of non-mark-to-market, nonrecourse term financing. At quarter end, such arrangements represented 77.1% of our borrowings as compared to 73.5% at December 31. Our total leverage declined further to 2.2:1 from 2.5:1 at December 31. We have $4.7 billion of total financing capacity across 12 discrete financing arrangements. During the quarter, we extended the investment period under our existing secured credit facility with Goldman Sachs for 2 additional years through 2026 and tacked on a 2-year term-out provision through 2028. Our only scheduled debt maturity in 2024 is $1.8 million under a credit facility we expect to extend or repay and terminate during the second quarter. We were in compliance with all financial covenants at March 31, 2024. At quarter end, we had $51 million of reinvestment capacity available, which we used in mid-April. We deployed into loans during the quarter approximately $196.2 million of reinvestment cash. The reinvestment windows are now closed for all 3 of our existing CRE CLOs, although we remain able to substitute in exchange loans under certain circumstances. Regarding liquidity, we maintain high levels of immediate and near-term liquidity, roughly 9.7% of total assets. Cash and near-term liquidity was $370.7 million at quarter end, comprised of $188.1 million of cash in excess of our covenant requirements. $51 million of CLO reinvestment cash has since been deployed, and $116.6 million of undrawn capacity under our secured credit agreements. As of last Friday, our cash position in excess of covenant requirements was higher at $235.5 million due to loan repayments and receipt of a $26 million service receivable in connection with the loan sale that closed during the fourth quarter of 2023. During the quarter, we funded $10.7 million of commitments under existing loans. At quarter end, our deferred funding obligations under existing loan commitments totaled only $163.8 million, a mere 4.6% of our total loan commitments. In summary, a quarter characterized by strong operating performance, solid credit, further optimization of our liability structure in terms of cost, non-mark-to-market borrowings, and extended tenor and significant liquidity through a balanced stance versus the market. And with that, we'll open the floor to questions.

Operator, Operator

Thank you. Our first question is from Stephen Laws with Raymond James.

Stephen Laws, Analyst

Congrats on a nice start to the year, Bob and Doug. Nice to see the stability here over the last couple of quarters. I wanted to touch on the CLO. I think it was around $50 million of replenishment capacity at quarter end. Did that get filled with a loan that was funded on a bank line or were there some originations post-quarter end? Can you talk to that? And maybe more generally kind of your origination pipeline and how you think about moving leverage from the current levels over the course of this year?

Robert Foley, CFO

Stephen, with respect to the $51 million of CLO cash that we deployed in April after quarter-end, in that particular instance, we actually took an existing loan that had been financed with the bank and deposited it into the CLO, which generated about $11 million or $12 million of cash. We borrowed less from our bank counterparty with respect to that loan than there was cash in the CLO. So we ended up netting about $11 million or $12 million on our balance sheet cash as a consequence of that redeployment. The cost of funds was clearly lower in the CLO than it was on the bank financing, and the coupon on the loan didn't change. Its residence is now different. It's CLO, not a bank financing arrangement. And I'm going to ask Doug to address your question about investment activity.

Doug Bouquard, CEO

Stephen, so on the investment side, we're excited about the fact that we are seeing activity more offensively and have a very active pipeline currently. If you look at our originations in the first quarter, which were 100% multifamily, we do still favor that sector, particularly now being able to deploy capital at a lower loan-to-value combined with, obviously, values being lower than they were in 2021 and 2022. So we still need to account them, one. But two, frankly, we're being selective. I think I mentioned earlier in my remarks about the mixed signals that we're getting from both the macro picture and also locally within real estate. So we're being respectful of where we are within the market cycle, but we are definitely able to play offense and continue to pursue new investment opportunities to help drive earnings growth for the company.

Stephen Laws, Analyst

Thank you for the insights on those topics. Bob, I wanted to discuss the debt situation. You mentioned in your prepared remarks the Morgan Stanley facility that is maturing at the end of this week. You haven't drawn anything from it, correct? I'm interested in your thoughts on the advantages and disadvantages of extending it versus letting it expire, especially since you still have over $1 billion in capacity on your bank lines. What commitment fees would you incur if you decide to extend it? Also, regarding the debt covenant coverage ratios, I know it reverted back at the end of the quarter, and you are in compliance. Can you provide an update on your current status with that ratio?

Robert Foley, CFO

Sure. First, regarding our arrangement with Morgan Stanley, they have been a key financing partner since we went public in 2017. We have a strong relationship with them. Currently, we don't have much borrowing with them for two reasons. Firstly, we haven't recently found alignment between our credit requirements and theirs. Secondly, our financing focus has shifted significantly towards non-mark-to-market term, nonrecourse financing, which is evident in the note-on-note and CLO financings we've completed since 2018. Although bank financing remains an essential part of our strategy due to its flexibility and speed, we've dedicated considerable time in recent quarters to assess our counterparty relationships and decide where it makes sense to continue and where it may not. As for financial covenants, we've complied at quarter-end as we have in previous quarters. We obtained a waiver from all our lenders that permitted our coverage ratio to temporarily fall below 1.4 times. Currently, we’re above that, and we have low leverage. As we invest more and potentially use additional leverage, we expect that our interest coverage will continue to meet benchmarks, even with the high rates we face today. I hope that answers your question. Now, I'll turn it over to Doug, who has some comments about the financing markets more broadly.

Doug Bouquard, CEO

Yes. And Steven, I think you do bring up a really important trend that we're seeing. As I think about the first quarter, the demand from the banks for loan-on-loan business is definitely as strong as we've seen it in a couple of quarters. I think that's really driven by a few things. One is that banks continue to pull back on direct lending. If they are going to be doing direct lending, they are generally pivoting more towards CMBS execution rather than actually a long-term balance sheet investment. Secondly, capital rules continue to push banks towards providing back leverage to platforms like TRTX. So on the positive side, as we think about our pipeline through 2024 and beyond, that amount of demand is a really positive tailwind for our platform, a trend that we expect to continue over the coming quarters.

Robert Foley, CFO

I think Doug's earlier comment about mixed signals in the market sort of highlights this particular point, which is demand by banks to provide financing is quite strong. I mean, we have a ton of inbound inquiry from our existing counterparties about borrowing more from them. The nature of the financing that they're providing to the CRE world has clearly shifted as Doug described. And honestly, spreads are coming in with respect to secured financing that can be obtained by lenders like us. The investment sales market for properties and the financing market for those transactions is a little more opaque and a little less clear right now, which is really the point that Doug was making earlier. So there's an interesting technical thing going on right now where financing costs are coming in, but loan spreads are kind of all over the place.

Operator, Operator

Our next question is from Rick Shane with JPMorgan.

Rick Shane, Analyst

Steve actually covered a lot of the ground I was interested in on the facilities. One thing, looking at the extension of the Goldman facility, spread stays the same. I am curious if there are any changes to the terms that we should be aware of, any sort of refinement of the credit box going forward?

Robert Foley, CFO

No, there are no material changes. We handle financing on a pay-as-you-go basis. Goldman has been a very important business partner for us and was actually our first credit counterparty when we were private. Regarding the credit box, as we've mentioned before, we see our portfolio liability providers and the construction of that portfolio as equally important as our investment portfolio. Each credit box is somewhat unique, but when we combine what we want with what we have, it creates a mosaic that fits our business. With Goldman, we are in alignment. I wouldn't say there has been any change in the credit profile at all, and those decisions are made on a deal-by-deal basis.

Rick Shane, Analyst

Got it. That makes sense. Given the history with Goldman, that's a significant renewal. As you transition back into making more loans, I'm interested in what you're observing in the market. Will capital deployment be unique each quarter, where we hear about specific opportunities and the reasons behind them? Or will there be a broader theme targeting certain market aspects, such as geographical areas or property types, as you reenter the market?

Doug Bouquard, CEO

Yes, I would say that for us, investing in the real estate sector is a priority, and this is reflected in both our debt and equity platforms. Regarding fees, we are aligned on several points. We've noted the supply for housing and recognize that while multifamily values have decreased from their peak, we can make new loans today at 65% LTV, which is appealing given that values may be 15% to 20% lower than before. This presents an attractive entry point. Additionally, from a team perspective, there are two specific areas to focus on. One is new acquisition activity, which is significant for everyone. We find fresh capital that reflects current market values to be appealing. Secondly, we are particularly interested in the segment of the market where regional banks were previously lending. It is widely recognized that banks are pulling back, and it’s notable that about 75% of all commercial real estate debt held by banks is with regional banks. These banks remain selective, as we have observed in Q1 while making loans. We maintain a bias towards housing, focusing on new acquisitions, and as we look ahead at capital deployment, we have positioned our balance sheet to navigate the mixed signals from the market. This is our approach to liquidity and new investments moving forward.

Rick Shane, Analyst

Doug, that's really helpful. I am curious as you start to look at multifamily, if you would just give some sort of context where cap rates were previously and where you see deals getting done today, and that's it for me.

Doug Bouquard, CEO

Certainly. The multifamily sector is currently a topic of considerable discussion due to the impact of macroeconomic trends like interest rates and inflation. New transactions are generally taking place in the mid- to high 5% cap rate range. As multifamily cap rates move into the 6% range, we see an increase in liquidity on the equity side. However, when the cap rates drop below 5.25%, that liquidity tends to diminish. I would consider the midpoint to be around 5.75%, which allows us to issue loans at stabilized debt yields between 7.5% and 8.5%, depending on the specific asset involved.

Operator, Operator

Our next question is from Eric Dray with Bank of America.

Eric Dray, Analyst

Most of them have been covered, but just wanted to ask about how have conversations with borrowers changed at all over the last month as kind of the rate outlook has changed a bit? And kind of what you're hearing from your existing borrowers?

Doug Bouquard, CEO

Yes. No, I think it's a great question. I think that broadly the narrative with the slowing of expected rate cuts combined with, I would say, what feels like over the past few weeks, a little bit of a slowdown in terms of that transaction activity. I think that's been kind of more of the dialogue that we've been hearing about. Relative to our current portfolio, obviously bearing in mind that it's 100% performing, I think that we generally would characterize the borrowing universe as still looking through the long term at a fact where long-term rates will settle and still looking fairly positive in terms of their ability to weather the storm with elevated rates in the near term. That's the best way to characterize the mindset. As that evolves, of course, I have to keep you updated, but that's where kind of the market is right now. Again, we're definitely at a pretty pivotal point, narrative-wise, just looking at what's going on within the macro environment. I'd say that despite our intimate knowledge of what's going on in the ground in the real estate sector, given our broad lens through which we invest, we're keeping an eye on what the Fed is doing and saying. I think this is really important, and we're very attuned to that message.

Robert Foley, CFO

All eyes are on 2:15 PM Eastern Time today.

Eric Dray, Analyst

Definitely. Okay. Awesome. And then real quick, just for modeling purposes. I mean, do you think that kind of the $0.30 distributable earnings that you posted this quarter? I mean, is that kind of like where you guys think the portfolio can maintain here in the next few quarters? Or any one-time things to call out?

Robert Foley, CFO

We never provide guidance, but I think that looking back at that number and its composition, I think it's pretty easy to see what's being generated by the loan book and what's being generated by our small REO portfolio. So we've been pretty clear about our dividend policy and our view about sustainable levels of distributed earnings and so on. But we're comfortable with our current position but can't provide any guidance.

Doug Bouquard, CEO

Yes. I think just to give perhaps a little bit more context, which is helpful. As you think about the sort of levers that we have to grow earnings, I would just think about what our balance sheet looks like. First and foremost, we have a substantial cash balance of approximately $371 million, combined with other available liquidity channels. Secondly, we are out there with a pipeline of potential investments that we could potentially pursue over the coming quarters. So just from a new investment perspective, that, of course, will drive earnings. Lastly, again, Bob's comment, we have approximately 5% REO. As we navigate through those assets and maximize value, that can also be recycled into newer loan investments, which will also grow earnings over time. I view that as a broader quantitative perspective.

Operator, Operator

Our final question is from Chris Muller with JMP Securities.

Christopher Muller, Analyst

Congrats on a great start to the year. So following up on some of the prior questions. Now that you guys are back to lending and the portfolio is cleaned up, should we expect to see some portfolio growth in the back half of this year? Or will it be more of a flattish-type portfolio? The root of the question is how aggressively do you guys want to match repayments with new loans over the coming quarters?

Doug Bouquard, CEO

Look, I'd say that from a strategic perspective, we really built the balance sheet for what I would describe as a sort of all-weather outcome. Acknowledging those mixed signals, we are currently sitting today, I would say it leans more towards the offensive. From a deployment perspective, I would expect us to be able to find new investments in the coming quarters. So as we think about repayments, repayments have slowed. That will be one of the byproducts, frankly, of both elevated rates, but also more probably elevated interest rates right now. Generally speaking, as I mentioned earlier about the three levers that we have to grow earnings, I would describe our ability and appetite to generate new investments at the top of the list to be able to grow the portfolio.

Christopher Muller, Analyst

Got it. That's helpful. And then the other question is, with some of your CLO financing out of the reinvestment period, can you just give your thoughts on if a new CLO is possible in 2024 and just how you guys are viewing that market today?

Doug Bouquard, CEO

Yes, sure. I think there has, of course, been a handful of series CLOs done recently in the market. It's a bit of an interesting dynamic right now where the available financing being provided from bank balance sheets continues to be more attractive than what we see with the series CLO market. Given that we're active in both areas, we're always looking on a daily basis at the delta between what kind of advance and spread terms we can get from banks on the balance sheet versus what the bond market will bear. Specifically, we will continue to optimize that going forward. I would say right now, to my earlier comment on banks, there is a lot of demand to put capital out. They're restrained from putting out direct lending capital and they have a lot of demand for providing financing for us. So I think that's really how we're looking at it. Series CLOs, of course, are a really important part of our capital structure. They provide a lot of flexibility and the benefits of master non-mark-to-market financing. However, I think at this point, series CLO spreads have lagged, and we are looking to have them come back to where they were historically about three or four years ago. For instance, AAA spreads were really tight at around LIBOR plus 80 basis points, but currently, we are still seeing series AAA spreads in the mid- to high 100s best case. So there's still a lot of compression to happen on the series CLO spreads side.

Operator, Operator

Before we conclude the Q&A, we do have a follow-up from Rick Shane with JPMorgan.

Rick Shane, Analyst

Having asked so many questions over time about repurchases, I think I'd be remiss not to address that. It's nice to see you guys announce a repurchase. I'm curious how you will approach that. It's a $25 million allocation. Do you expect to be pretty consistently in the market? Or is that something that will just be there very defensively if you see some really bad days?

Doug Bouquard, CEO

Yes. Look, I think on the share repurchase side, first and foremost, it's a tool in our toolkit, which we acknowledge and have used over time as really a powerful way for us to both enhance earnings for the company. Also, I think there's a real statement about the fact with the credit quality of our current book relative to book value, buying shares at today's market price is attractive. In terms of going forward, all I can say at this point, Rick, is that it will continue to be a tool in our toolkit. We will continue to use this as a potential way to drive our company.

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 management for closing remarks.

Doug Bouquard, CEO

Just want to thank everyone for taking the time to join the call, and I look forward to speaking to all of you next quarter. Thank you very much.

Operator, Operator

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