TPG RE Finance Trust, Inc. (TRTX) Q2 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the TPG Real Estate Finance Trust Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Brad Cohen or ICR. Thank you. You may begin.

Good morning, and welcome to TPG Real Estate Finance Trust's second quarter 2018 conference call. On the call today are Ms. Greta Guggenheim, Chief Executive Officer; and Mr. Bob Foley, Chief Financial and Risk Officer. Greta and Bob will share some comments about the quarter, and then we'll open up the call for questions. Yesterday evening, the company filed its Form 10-Q and issued a press release with coding a supplemental earnings presentation detailing its operating results for the quarter ended June 30, 2018, all of which are available on our website in the Investor Relations section. Let me 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 the company's operating results, please see the Risk Factors section of the company's Form 10-Q filed on August 6, 2018, with the SEC. The company does not undertake any duty to update forward-looking statements. During this call, the company will also refer to certain non-GAAP measures. For reconciliations of these non-GAAP measures, please refer to the Form 10-Q and earnings supplemental, which are posted on the website and have been filed with the SEC. With that, it is my pleasure to turn the call over to Greta Guggenheim, Chief Executive Officer of TPG Real Estate Finance Trust.

Thank you, Brad, and good morning to everyone on the call. Thank you for joining us, as we present our second quarter results. It was an excellent quarter and it’s been a great year-to-date through early August. In the second quarter, we continue the strong pace of originations established in the first quarter by closing seven first mortgage loans totaling $609 million. For the first six months of 2018, we originated $1.2 billion of first mortgage loans with a weighted average credit spread of 343 basis points. Our year-to-date originations are $1.8 billion including seven loans totaling $637 million that have closed are in the process of closing since June 30th. This volume nearly equals the amount we close in all of 2017. The weighted average loan to value of originations in the second quarter was 72% on an average loan size of $87 million. The small quarter-over-quarter increased in loan to value reflects our focus on cash flowing bridge and light transitional assets which comfortably support higher advance rates by us to our borrowers in higher leverage to us from our lenders. Year-to-date, our weighted average loan to value is 68%, which includes the $637 million originated since quarter end, which have a weighted average loan to value ratio of 62%. For the second quarter, our weighted average credit spread was 308 basis points. Our average credit spread was higher in part due to $190 million first mortgage loan with a credit spread of 270 basis points. This is the tightest spread we have originated in TRT’s history. By contrast, the weighted average spread for the $637 million source subsequent to quarter end is close to 400 basis points at 392 basis points over LIBOR. Over $420 million of this resource directly with bars. Having these deep relationships able us to not rely on heavily mass marketed broker deals. Year-to-date, our weighted average credit spread is 360 basis points. Please note that these attractive spreads were achieved without our origination of construction or mezzanine loan. It is difficult to extrapolate trends based on quarterly activity, because large loan originations are quite lumpy and as a late closing can skew one quarter's result. Spread compression has been a fact of life recently but it has not been a road block to our progress. Our experience team has successfully utilized our deep relationships with borrowers and brokers which have been established over decades of lending and our extensive credit knowledge to source the most attractive lending opportunities. We added a senior originator to our originations team during the second quarter to provide additional fire power, also contributing to our positive momentum is our integration with TPGs real estate equity investment team and its ownership of 87 million square feet of commercial real estate in the United States, this greatly enhances our loan sourcing and loan evaluation. Our reputation for responsiveness in deep engagement during the origination and asset management stages of our business is another TRT differentiating factor, we strive to be the first call for every borrower next investment and our results suggest it’s working. For example, three of the seven loans we originated in the second quarter were with routine [ph] borrowers and the remaining four loans involve borrowers and or brokers within we have deep long-term lending relationship. We remain disciplined in avoiding unwanted credit or tail risk down the road. For example, we don’t target new construction loans given the very mature real estate cycle. We focus on diversified originations by size, geography, property type and sponsor in a mindful of concentration risk in our portfolio. We prefer to concentrate our efforts on loans with shorter term business plans, strong sponsorship with skin in the game and strong underlying real estate fundamentals. We believe our continued focus on disciplined deployment is evident in the quality and volume of our year-to-date loan originations. While the market is competitive, we are encouraged by our year-to-date origination volume of over $1.8 billion, which nearly equals our entire production for fiscal year 2017. Again, all of this is first mortgage loans are predominantly very wide transitional, cash flowing assets and with a weighted average spread of 360 basis points. We are also excited about our robust loan pipeline, many of which are very far long in the underwriting process. Credit quality remains our top priority and we feel very good about the quality of our loans and the risk adjusted returns. With that, I’d like to turn the call over to Bob, to discuss our results.

Thanks, Greta, and good morning, everyone. Since detail regarding operating performance, the loan portfolio, per capital base and other key performance indicators are contained in the 10-Q and the earnings supplemental which we filed last night. This morning, I’ll limit my remarks to a few items of particular interest. First, our second quarter performance. We posted GAAP net income of $26.4 million, or $0.44 per diluted share, as compared to $25.1 million or $0.42 per diluted share, for the preceding quarter. Earnings growth of 5.2% was driven primarily by net loan growth and loan assets of $206 million and a continued decline in our weighted average credit spread on borrowings of approximately 9 basis points quarter-over-quarter. MG&A expense was in line with expectations, down roughly 3% and up 64% quarter over same quarter of 2017, due to various first-time costs as a public company. Book value per share was $19.80 at quarter end, versus $19.82 at prior quarter end due to a non-cash mark to market adjustment of $1.4 million, largely related two Ginnie Mae guaranteed multi-family project bonds that we account for as available for sale securities. This has no impact on earnings. And we declared in mid-June and paid in July, a cash dividend of $0.43 per common share, an increase of $0.01 per share over the prior quarter. Our annualized dividend yield is now 8.7% on our book value per share at quarter-end and 8.3% on Monday’s closing share price of $20.69. During the second quarter, we originated seven loans totaling, $609.4 million. Initial fundings under new loan commitments totaled $531 million. Loan repayments were $414.6 million, lifting repayments with a first half of the year to $571 million, which is in line with our expectations. Second quarter repayments included $129.7 million relating to our dwindling number of legacy construction loans, including our $89.7 million share of a condominium construction loan in South Florida, that was repaid in its entirety when our borrower closed 306 of the 533 signed existing purchase contracts in eight weeks, that’s a daily average of almost eight contract closings. Repayment of our legacy construction loans is expected to continue through the end of the year. The ratio of initial loan fundings to new loan commitments for the quarter was 87.1%, which again highlights our continued emphasis on bridge and transitional loans with limited amounts of deferred funding. With this discipline, we put more capital to work at loan origination and we reduce our exposure to business plans with Link B execution periods. Accordingly, our unfunded loan commitments continue to decline quarter-over-quarter to $483 million, down $48 million from the prior quarter. In the second quarter, we acquired for short-term investment purposes approximately $74.9 million of high-grade CMBS, using proceeds from loan repayments. In late July, we sold approximately $133 million of our CMBS portfolio to fund our existing loan pipeline. Our experience and knowledge of commercial real estate and structured finance allows us to efficiently generate a meaningful yield pick up on cash for short periods as compared to repaying repo borrowings or investing in corporate commercial paper or other investment products. A solid consistent return on equity is the result of our platforms continuing commitment to direct origination, leveraging the TPG platform, disciplined underwriting and credit decision making, attentive asset management and the prudent use of leading edge financing. We managed these attributes to produce attractive ROEs generally by targeting first mortgage loans with modest loan to value ratios, solid in place debt yields and then pairing them with advanced rates appropriate for their risk. Portfolio wide asset level leverage rose to 74.8% from 71.3% in the prior quarter. And for loan investments pledged during the second quarter, the lender approved weighted average advanced rate was 79.7% and the weighted average credit spread was LIBOR plus 178 basis points, both demonstrating continued quarter-over-quarter improvement. We executed during the quarter our CLOs first two replenishments, which allowed us to recycle $56.9 million of loan repayments in our CLO in order to maintain leverage at 80% at a cost of LIBOR plus 108 basis points. Our debt-to-equity ratio increased to 2.421 from 2.1421 during the prior quarter further evidence of our success in ramping capital deployment in leverage, which are key drivers of ROE and dividend growth. We do expect to tap the structured finance in private debt markets in future quarters to further reduce our cost of funds, extend the tenure of our liabilities and increase our use of non-recourse, non-mark-to-market borrowings. At quarter-end, our liquidity and capital position were healthy. In addition to cash balances of $42.5 million we had available to fund new investments $64 million immediately available undrawn capacity under credit facilities, our high grade CMBS investment portfolio totaling $218 million, of which I mentioned $133 million was converted into cash in late July or near-term deployment into new loan originations and $1.1 billion of available financing capacity under our secured revolving repurchase agreements and our warehouse facility. In total, $3 billion of committed financing capacity. In July, we closed with Citibank, a $160 million full recourse table funding credit facility to enable us to close new loans more quickly than as usual, then repurchase another secured credit facility. This allows us to be even more nimble in meeting borrower requirements for quick closings which can also occasionally generate premium pricing to us and it affords us a window during which we can optimize our financing decision whether repo syndication, note on note, CLO or otherwise. The targeted leverage of 3.5 to 1, our estimated potential new loan investment capacity is approximately $1.1 billion. By comparison, as Greta mentioned earlier, we currently have a large pipeline of $636.6 million of loans closed or in the process of closing since quarter end. Credit performance remains solid. At quarter end, we had no loans or non-accrual status and we did not record a reserve for loan loss. At quarter-end, our portfolio’s weighted average risk rating was 2.8, up slightly from 2.7 for the prior quarter driven by the repayment of highly rated loans, $609 million of quarterly originations that garnered the expected initial rating of 3 or slightly better than 3. And the transfer from category 3 to category 4 of a first mortgage loan with the near-term maturity. Also, in July, we sold a 4 rated loan, a $2.7 million participation interest in a non-core fixed rate loan acquired from Deutsche Bank in late 2014. We sold this loan, because it is not consistent with our large loan investment strategy. After this sale, which represented nearly 7 basis points of our loan portfolio at quarter-end, the former Deutsche Bank portfolio represents less than 5% of our loan book. Finally, rising rates are positive for us, since substantially all our assets and all our liabilities are tied to the same LIBOR index. In addition, we generally require our borrowers to purchase out of the money interest rate caps to protect them and us from sharp rises in interest rates that might occurred during the term of our loans. And we underwrite our loans with the conservative forward view of rates and their impact on future debt service coverage, cap rates and collateral value. And with that, Greta and I would be happy to entertain your questions. Thanks very much. Donna?

Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Stephen Laws of Raymond James. Please go ahead.

Hi good morning, Bob and Greta congratulations on a solid portfolio growth and a solid quarter.

Thanks.

Greta, I know you mentioned specifically you hated to try and draw a trend out of where spreads to LIBOR on new assets, new investments are going. But I got some of the follow up on your prepared remarks. It seems like things have rebounded since quarter-end. Is there something you're seeing in the marketing? Is that simply a function of just small sample sizes with the origination volume first and second quarter and then subsequent to quarter-end. Maybe can you go in a little more detail about asset yields on new investments, how those have come back a little bit and where you see them going from here?

Well, there has definitely been spread compression. I mean our year-to-date spreads of 360 are less than 2017 full year spread. So that avoiding comparing quarter-to-quarter but trying to compare larger chunks of time. And in looking at those periods, it's clear -- our spreads have clearly come in. But that being said, I feel like we certainly since quarter-end as our originations indicate, we are getting what I believe are very strong spreads on very high-quality originations. And it is in part a result of having direct relationships and borrowers and brokers and not relying solely on mass marketed major national mortgage broker deals, where force to compete with maybe 20 other lenders and been the very tightest to win. I mean we will do those transactions, because it is important to stay in the flow. But we so far have been able to rely on our deep relationships to get differentiated pricing on high quality deals. And also, I think the larger, the loan size the more competitive the loan. Now there is a certain size where it thins out, but when you're in the $200 million to $400 million size, I think you see a lot of interest from some of our larger or some of the other public mortgage REIT as well as private debt funds. And our average loan size is slightly less than a $100 million. We believe it's less competitive. And I think our results prove that out.

You actually hit exactly on my second question to ask about what you're seeing in the top-five or 10 MSAs versus the smaller markets I guess where smaller loans typically take place. And so, it does sound like you're seeing less competition at the low end. Has that changed your focus at all, or has it continued just to go through the pipeline and look at each individual investment on its own terms.

We're still focusing on the major markets. and very high percent of our originations. I think it's over 60% are in the top-10 market -- of our portfolio in the top 10 market. You're not going to see our strategy shift materially in that. it's more the relationship with the sponsor and not chasing $250 million to $300 million loans and competing with the world.

Right. And Bob, as we think about the portfolio in the second half of the year, you gave goof information on originations subsequent quarter end. Are there any prepays, can you maybe give us any insight under prepayments, I know the loan table has the fully extended maturity, but what’s the state of maturity or do you have a good sense of maybe where prepays will be for the second half of this year.

Good question Steve. And as you and other on the call know, we have a very attentive asset management platform and one of the many advantages of being in the intermediate to large loan business as you can, and you should manage your loans individually. And so, we’ve – we’re in constant touch with our borrowers and we try to accurately forecast what we expect will be the repayment behavior of each and every loan, there is clearly some variability, quarter-over-quarter, often driven more by the underlying business plans and by general capital markets conditions. I think the sub text of your question is what should you expect for the rest of the year and I would say that our expectations now are that repayment behavior for the rest of this year should be consistent with what we experienced over the first two quarters of the year taken as a whole. There will be variability and that’s often the case that the aggregate dollar amount of repayments that occur in a given half year or a year will be very close to what we project, but the actual underlying loans that repay could vary. I mentioned that conduit deal in South Florida earlier. We did not project that that sponsor would close as all the contracts have been signed well in advance, that was really the premise of our investment decision. But that particular borrowers is extremely good at closing deals. They operate in a multiple conference rooms, that drive borrowers around to get to their bank to bring their final bank check-in and so that deal actually closed out a little faster than we thought. That’s just one example of the variability that can occur and repayments. But we would expect the second year to look like the first half, or the second half of the year to look like the first half of the year.

Great, I appreciate the color on that Bob. Thanks for taking my question.

Thank you for the question.

Thank you. Our next question is coming from Steve Delaney, of JMP Securities. Please go ahead.

Good morning and thank you for taking the questions. Great, you mentioned the large loan, the large office loan that was priced at LIBOR plus 270. Would that be the loan highlighted on page nine in Philadelphia.

Yes, it is.

Okay. Could you just comment on what made that loan, specifically attractive in terms of LTV, it looks pretty much like some of the other loans. What was attractive to that and I guess the second part of the question would be to Bob, that would that loan is there anything about that loan that would cause to finance better than another loan. Just curious if the decision process that you went through other than the fact it was putting a lot of money to work? Thanks.

Sure, look that loan is consistent with our strategy and most of our other originations of major markets, very strong sponsor and high-quality assets. But it is also with the borrowers that I personally have lent [ph] to over a long period of time and have had great experience with. The borrower is excellent at executing their business plan and it has a very good history of abiding by the loan documents that they signed which obviously is important to us. So, this is one that we leaned in on as I mentioned before larger loans are teemed to be a bit more competitive and given our comfort with the sponsor, we chose to lean in on this one to win it and you may see us to that from time-to-time.

Understand, that’s a normal part of relationship management and holding on to your good clients. Kind of directly extension to that is, I notice that in the quarter 95% of the loans run office properties. Was that intentional on your part, where there any multiple loans to the same borrower, and what should we, it’s always going to be a big part given your market focus. But anything behind the 95% concentration in the second quarter we should understand?

That wasn't a goal set out at the beginning of the quarter to have that high of a concentration. Office is 36% of our portfolio. We continue to like office. We're shying away from retail. We're very, very selective on hotel. So, it really leaves office and multifamily as our primary focus. Not to say we won't do retail or hotel, but we're just much more selective. But this was not a target, it just happened. And there are repeat borrowers in there. Three of the loans are our barrowers that we have financed before at TRTX.

Great, thank you. And Bob, one for you. I noticed, in the -- in your deck you talk about the sale of the CMBS positioned and you mentioned in your comments as well. Liquid asset helps to free up capital to fund your growing pipeline. Just curious, if in the third quarter from an accounting standpoint, if we should consider whether they would be any GAAP gain that would be recognized on that sale, anything above where they were maybe being carried at the 630 fair value mark? Thanks.

Thanks, Steve, for all of your questions. I would say that's unlikely are with a few exceptions. Our CMBS investment activity is driven primarily by our desire to invest cash thoughtfully for the short-term when we have it, prior to us deployment and whole loans. And to do so, we generally buy very short duration AAA rated primarily floaters. Sometimes some short remaining life fixed rate loans. But as a consequence, that the price volatility, the DVO, one of those bonds is very low, which it should be given that this is intended to be a cash substitute. And as a consequence, I don't think that people should expect to see material gains or losses from our CMBS investment activity.

God it. Thank you. I appreciate the comments.

Thank you, Steve.

Thank you.

[Operator Instructions] Our next question is coming from Rick Shane of JP Morgan. Please go ahead.

Hi guys. Thanks for taking my question is this morning. I appreciate the additional disclosure on page six related to the origination efforts in the pipeline. I just want to make sure that we understand whether or not the loan pipeline cited on page eight indicates with footnotes for describing that the pipeline is the reference of same pool of loans on the subsequent events page that description?

Yes, it does.

Okay. So, we look at this, subsequent event almost in the process of closing. And then on page eight, it basically says, pipeline and does not suggest that those are closed loans. I'm curious given how favorable those metrics are whether or not you expect a little bit more fallout in that pipeline versus what you normally look?

No, we do not. Many of these are acquisition loans and so we believe that they will close as scheduled because the borrower doesn't want to miss that deadline. And also, over, approximately half of these will be closed by the end of this week or at least that's our expectation.

Okay, great. The disclosure in asset level estimated return is very helpful. I'm assuming when we look back at overtime, what we've seen is that through the first half of 2018, or fourth quarter of 2017 and the first quarter of 2018, there was some offset in terms of the spread compression presumably driven by more efficient financing. In the second quarter that sort of run away because that financing isn't in place. I am curious of ultimately there is going to be any benefit from scale as well when you make that calculation?

Rick, I’ll take that question and thank you for it. You're right with respect to our ROE, which is a net ROE after expenses and so on, on an asset-by-asset basis. But we do expect that there will be benefits overtime scale, both as our book grows and as the company as a whole grows. MG&A as we’ve discussed previously we believe we’re at a good scale and we have significant operating leverage embedded into the business. We’ve gotten past a lot of the start-up public company cost especially over the last couple of quarters. So, we do think there’s some benefits there. But bluntly, the big benefit overtime of either improving or sustaining our ROE is making good investment decisions having our team use their direct relationships to sort of skin the cream of the crop in terms of deal opportunities and then for our capital markets team to finance things really efficiently and we’ve made very good headway in that regard, but we still have work to do. The CLO that we did in the first quarter I think was an important milestone for us but there are other techniques available to us especially in reliance on the bigger capital markets team here at TPG and we would hope to exploit those overtime.

Got it. So, to really pinpoint on it, it's fair to say that the spreads and yields -- so you’ve provided the metric that asset level with ROE for four quarters. Fair to say that the spreads and yields have been dynamic, but funding assumptions has been dynamic, has the operating expenses associated with that been dynamic or has that been a static function that ultimately will improve?

I would say that the operating expense results have been closer to static, but if you spread our MG&A over the last several quarters, you’ll see that it’s flat in fact this quarter was slightly down quarter-over-quarter and we don’t -- in terms of MG&A, professional fees, operating expenses, asset management and servicing fees were on those like the hawk and we think that those are sustainable levels for an extended relevant range of business volume, let’s put it that way.

Okay. Great. That’s very helpful. Thank you, guys.

Thank you. At this time, I would like to turn the floor back over to Ms. Guggenheim for closing comments.

Thank you again for joining us this morning. We look forward to seeing you and speaking with you on the conference circuit and on the road over the next three months. In the interim, we hope you enjoy the last few weeks of summer.

Ladies and gentlemen, thank you for your participation. This concludes today’s conference. You may disconnect your lines at this time and have a wonderful day.