TPG RE Finance Trust, Inc. (TRTX) Q3 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the TPG’s RE Finance Trust Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Deborah Ginsberg, Vice President and Secretary. Please proceed.

Good morning, and welcome to TPG Real Estate Finance Trust’s Third 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, we filed our Form 10-Q and issued a press release with a presentation of our operating results for the quarter ended September 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 our operating results, please see the Risk Factors section of our Form 10-Q filed on November 3, 2018 with the SEC. The company does not undertake any duty to update the forward-looking statements. During this call, we 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’s my pleasure to turn the call over to Greta Guggenheim, Chief Executive Officer of TPG Real Estate Finance Trust.

Thank you, Deborah, and good morning all. We had another strong quarter with originations of $710 million with a weighted average spread of 403 basis points, a 61% LTV and a 9.7% ROE. Through the third quarter, our originations totaled $1.9 billion, an increase of 31% versus the same period last year and comparable to 2017 full year production. Our Q3 originations were diversified by property type and location consistent with our portfolio. 80% were in top 10 MSAs, 100% were first mortgages and 100% were light, transitional or bridge loans, where deferred findings are less than 20%. Fundings totaled $643 million, including $57 million of deferred fundings related to existing loans. Loan repayments were $290 million and our commitment screwed a $4.7 billion and our unpaid principal balance increased by approximately $1 billion or 31% since the beginning of the year. As we previously forecast, our construction and condominium loans declined by 82% and 59%, respectively. Construction loans now total $109 million or 2% of our total portfolio, and this is before taking into account executed sales contracts on condominium loans, which comprise our construction loans. Loans secured by retail and hotel properties are 5% and 13% of our portfolio, respectively. We have been cautious on these two property types, but do sometimes see opportunities with very strong credit characteristics coinciding with favorable returns. A recent example is the retail loan we closed in the third quarter. What we liked about this loan are: it is anchored by a recently expanded and renovated Walmart Supercenter Grocery Store, and we very much like necessity-based retailers; a 55% LTV and LTC and the fact that substantial new equity was contributed when we made the loan and, of course, the very strong experience of our sponsor. Even with this $59 million loan, our retail exposure remains at only 5% of our portfolio. Office and multifamily loans represent 38% and 20%, respectively, of our portfolio. We continue to focus on loans secured by these two property types and our pipeline reflects this preference. Since September 30, we have source loans totaling $540 million and we’re actively working to close additional opportunities by year-end. We see robust loan demand, driven in part by the substantial amount of capital raised by real estate, private equity funds as well as other buyers. To help us take advantage of this strong loan demand, we hired two originators in Chicago, enabling us to better cover Midwestern and Western cities. On the capital front, we raised $139 million of common equity in early August, and we also closed $160 million table funding facility with Citibank. I would now like to spend a few minutes talking about credit. At this point in the cycle, credit discipline will be continually tested. The lending environment is very different from three or more years ago when property fundamentals were substantially improving, valuations remain muted and interest rate had not begun their ascension, even inexperienced lenders will build out. Now assets are priced to perfection and there is ample debt financing. Our experience tells us that in the next several years those with strong credit skills and experience will fair best. Accordingly, we stress test our loans assuming interest rates and cap rates rise and property operating performance flows. Equally important, we’ve instituted what we consider the best-in-class asset monitoring and internal reporting systems and procedures. We have separate origination and asset management teams, which helps promote objectivity in evaluating assets. We have 10 professionals involved in asset management, of which seven are 100% dedicated to this function. On a weekly basis, our management team meets with our asset managers to review pending requests, review our followthrough on prior requests and assess new developments in our loan portfolio. On a monthly basis, we perform an in-depth review on a subset of our portfolio, and on a quarterly basis, we do a comprehensive portfolio roll up with the entire asset management team, senior management team and investment professionals. We discuss each asset in depth comparing current performance to the bars business plan, our underwriting and current market conditions. At the end of each quarter, we perform a re-underwriting and revaluation of each loan in our portfolio. These results are evaluated by internal valuation committee, which includes senior management as well as a member of the TPG Real Estate equity team for their perspective on value. Our risk rating system is an integral part of this process, and we seek to operate with full transparency and report results of our proactive asset management. This level of individual asset oversight bolsters our credit preservation and risk management processes, but also allows us to foresee potential early repayments of assets whose performance is exceeding the underwritten business plan, which, therefore, makes these loans candidates for a refinancing. We are very proactive in modifying highly performing loans so that they will stay outstanding for a longer period of time. We believe that our portfolio is very strong and that our loans are well structured to be resilient in different market conditions. With that, I will now turn the discussion over to Bob.

Thanks, Greta. Good morning, everyone, and happy election day. Complete details regarding our operating performance, loan portfolio, capital base and other key performance indicators are contained in the 10-Q and the earnings supplemental, which we filed last night. I’ll cover a few key items now, and we’ll be pleased to take your questions at the conclusion of our remarks. For the third quarter, we registered GAAP net income of $26.8 million or $0.42 per diluted share. That compares to $26.5 million or $0.44 per diluted share for the preceding quarter. The quarter-over-quarter change in GAAP net income and core earnings per diluted share was due primarily to an increase in our share count and that related to our $138.7 million equity offering in early August. Earnings growth for the quarter of 1.5% was driven by net loan growth of $353 million, and a continued decline in our weighted average credit spread and borrowings of approximately eight basis points quarter-over-quarter. Our MG& A expense was in line with expectations, down quarter-over-quarter by about 4%. And our book value per share at quarter end was $19.78 versus $19.80 at the previous quarter-end. We’ve included bridges for book value and GAAP earnings per share on Page 6 of this quarter’s earnings supplemental. We declared in mid-September and paid in October a cash dividend of $0.43 per common share, unchanged from the prior quarter. Cumulatively, since January 1 of this year, dividends declared and paid equal approximately 100% of our earnings. Our annualized dividend yield is 8.7% on book value per share at September 30 and 8.6% on Monday’s closing share price of $19.98. During the third quarter, we originated seven loans, totaling $709.5 million. Initial fundings under new loan commitments total $585.9 million, and loan repayments were $289.8 million boosting loan repayments for the nine months ended September 30 to $861 million, which is consistent with our pacing expectations through year-end. During the third quarter, our repayments were a bit front-ended and our originations are bit back-ended. Third quarter repayments were spurred by $174.5 million of repayments on legacy condo construction loans, as Greta described. Year-to-date repayments on construction loans totaled $388 million, leaving us with only $98.3 million of UPV at September 30. The ratio of initial loan fundings to new loan commitments for the quarter was 82.6%, consistent with our continued emphasis on bridge and transitional loans with short business plans and modest amounts of deferred funding. Unfunded commitments increased to $527.1 million from $482.8 million at June 30. In late July, we sold $133.7 million or roughly 61% of our short-term CMBS investment portfolio as of the end of the second quarter, and deployed those proceeds into new loan originations. Those short-term cash substitutes had a weighted average coupon of about 2.9% and produced solid incremental revenue during a short holding period. Portfolio wide, loan level leverage decreased to 69.6% from 74.8% in the prior quarter due to our decision to temporarily repay higher cost repo borrowings with proceeds from our August equity raise. The loan investments pledged during the third quarter, excluding one loan pledged to our recourse table funding facility, the vendor-approved weighted average advance rate was 78.1% and the weighted average credit spread was LIBOR plus 201 basis points. We executed during the quarter our CLO’s third replenishment recycling $35.9 million of loan repayments in our CLO to maintain leverage at 80% at a cost of LIBOR plus 108 basis points. Since inception in February, our three replenishments have recycled $92.8 million of loan proceeds. We continue to focus on arranging match term funding for our loan portfolio and further reduce our cost of funds. TRTX 2018-FL1, which we completed in February of this year, was an important first step in this strategy and you should expect us to do more in this regard. At quarter-end, our liquidity and capital position was healthy. In addition to cash balances of $46.2 million, we had available to fund new investments $258.2 million of immediately available undrawn capacity under our credit facilities, a high-grade CMBS portfolio totaling $77 million and $1.2 billion of available financing capacity under our financing arrangements. In total, we have today approximately $3.3 billion of committed financing capacity. And at targeted leverage of 3.5:1, our estimated potential new loan investment capacity is about $1.3 billion, more than ample to fund our current pipeline of $540 million. Credit performance remained solid. At quarter-end, our portfolio’s weighted average risk rating was 2.8, unchanged from the prior quarter. Finally, rising rates were a positive for us, since all our assets and all of our liabilities are tied to the same LIBOR index. Additionally, we 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 occur during the term of our loans. And as Greta described earlier, we underwrite our loans with conservative forward view of rates and their impact on future debt service coverage, cap rates and collateral value. With that, Greta and I will be happy to entertain your questions. So thanks very much. Operator?

[Operator Instructions] Our first question comes from Steve Delaney with JMP Securities. Please proceed the questions.

Good morning and thank you for taking my question. Bob, you provide in your deck, which you referred to as an asset level estimated ROE of 9.7%, we just took a little step further today and calculated a core ROE of 8.5%, it was handy your offering hit right in the middle of the month, so wasn’t a lot of brain damage there to get average equity. Curious, how you view that in terms of the 8.5% in terms of if there is room from – for upside there in that important ratio and what are the two or three steps that you guys are going to have to take to see that core ROE move higher?

Sure. Steve, thanks for you question. I think the steps that we are taking and that will allow us to experience and for investors to enjoy some upside is: first, continued capital deployment, which Greta has commented on and can provide more detail on, but scale is important in this business, and provided we can continue to find the best risk-adjusted returns on an individual loan basis, as we close more of those loans, deploy the capital that we raised in August, the scale benefits are pretty significant, let’s put it that way. I’d say the second thing is, as our use of leverage and lower cost leverage, we layered in almost $800 million of very attractively priced liabilities in February with our first CLO, we’ve taken steps with respect to our repo and other financings to further reduce our borrowing cost. As we do that, not only does our asset-level ROE improve, but as we recycle capital, our corporate-level ROE improves as well, because we’re able to recycle existing credit facilities, which we’ve already paid for. And frankly, spread more borrowing and more investment earnings over a fixed amount of fixed financing transaction costs. So – and then the third thing, I would say, is scale-related and really a matter of discipline and that is, as we continue to grow the company, we experience the benefits of scale in terms of fixed number of people being able to do more work, and we continue to push to control and, in some instances, reduce our operating expenses. And so that’s the third important ingredient.

So that’s very helpful, I ask for two or three and you gave me three so thank you. And I’m hearing in your response that there is room for that 8.5% figure to move higher, I’m not asking for guidance, but sounds like you did see room for…

That’s because we want to provide it. Yes, there is upside and it’s largely a function of the team continuing to do what is done each quarter and especially this quarter, which is accretively deploy increasing amounts of capital. $710 million of loan production in a single 90-day period is a pretty strong result.

At a 400 basis points spread.

Yes, at 403 over.

Yes, and 500 already in the fourth quarter. So that’s it thanks for the comments and that’s help me for this morning.

Thank you, Steve.

Our next question comes from Ben Zucker with BTIG. Please proceed with your question.

Good morning everyone. Thanks for taking my question. Let’s see, Greta, I heard in your prepared remarks that you hired two originators out in Chicago. What does that bring your originator headcount to? And how do you feel about your footprint and coverage of the country at this time? Are there any markets where you feel like you are maybe still punching below your weight and could make sense for expansion?

Sure. We have five senior originators, who are really the rainmakers in our group. We also have another seven, I’d call them, associates and VP level and analysts to support them. As well, I am very, very involved in originations as I have communicated in the past. And I think that we are hitting our stride, I think we have a differentiated approach to originations, and – which enables us to get, I think, a higher return versus the risk-type asset on our balance sheet. I mean, if you look at our weighted average spread year-to-date, it’s 370, there is – without going into construction loans or mezzanine loans. So I think that’s a pretty phenomenal accomplishment, particularly, if you look at some of the other originations being done out there. And as I’ve mentioned, we are credit-first and spend a lot of time on that. I feel – I think we all feel very strong about the credit in our portfolio. But yes, our – we believe, we can scale with our existing staff. When we find a great originator, we believe that you always are a great talent and – so could we hire more next year? Absolutely, if we find some great talent out there. But we do believe that we can scale our business with a team that we have in place.

That’s very helpful, Greta. Let’s say, can you just talk about the market a little bit, since you’re commenting and you seem to be sending the message that you guys were able to find this better, more compelling risk reward. What are you seeing in the overall market? What are the areas that you guys are staying away from as a firm? What are the areas that you like, maybe both on property type and geographic region right now? Just curious for your higher-level approach.

Well, we have avoided mezzanine loans in large part. If we do a mezzanine loan, it is really to facilitate a financing and we haven’t done that this year, we have done in prior years. We would do it again, if we needed to facilitate a senior financing, but the underlying loan would really be structured, as I hope first mortgage loan and just create the mezzanine for financing purposes. But we don’t – we have stayed away from mezzanine. And at this point in the cycle, I think you’re going to see a stay away even more so. In that, when assets are fully priced and you need to go up and leverage to do a mezzanine loan, you don’t participate in the upside in the asset, even though you might be at a leverage point where one could argue you should, and you only have the downside risk. So we’re really avoiding the higher-levered mezzanine play today, even though you can do short yield by originating those types of assets. So that’s one category. We are – we and I think most of our peer set is in the same boat, still very cautious on retail. I think there’s going to be more disruption in that space, so we’re very cautious. We did do the one I mentioned. It was a necessity-based Walmart Supercenter Anchored Center, but we’re avoiding that category in general. We have said in the past that we’ve avoided or that we were very cautious on hotels and overbuilt markets, such as Manhattan. Frankly, the rep power of Manhattan hotels had declined for three consecutive years. In 2018, it, sort of, turned around and while there is still new construction coming online, the big peak of new construction has subsided. So you may see us tip out toe in the water in Manhattan hotels again, if we find the right opportunity. And – but in general, we are cautious on markets, where there is a lot of supply in the hotel space, particularly boutique-type hotels.

That’s Very helpful. And then just lastly and this is a little more housekeeping and maybe it’s geared towards Bob. Could you provide any color on your expected 4Q 2018 repayments? You did provide some commentary around the 4Q pipeline, but as everyone knows, that’s really only half the equation and I mean any kind of guidance, even if you could say something to the effect of, we expect this to be a normal quarter for our business under standard assumptions, I think, that would be very helpful as most analysts now focus on the deployment story.

Right. Very fair question. I think that your description is accurate. I think that our pace during the first three quarters is a very good indicator of what our fourth quarter repayment activity will be. And I think that our full-year repayment activity will be consistent with prior years, maybe a little bit less. But I’d say that the first three quarters of this year are the best predictor of what’s likely to happen in the fourth.

Clear well thanks for my taking my question.

Thanks.

[Operator Instructions] Our next question comes from Don Fandetti with Wells Fargo. Please proceed with your question.

Bob, I want to ask a little bit more around the condo. Clearly, you’re at 2% of the portfolio, have done a great job bringing that down this quarter. And I think it’s even lower if you adjust for potential sales. Can you talk a little bit about where your remaining exposure is? And if those sales can be broken? And then lastly, could you just talk a little bit about the condo market in New York and Florida? Are we seeing more signs of distress? Clearly, rates moving up has slowed home and condo sales significantly around the country.

Sure. Thank you for you question, Don. First, with respect to our remaining condo exposure, we have one construction loan remaining, as Greta described earlier. It’s in South Florida, and it’s a project that has sold extremely well since inception, and it’s now in the sellout phase. So we expect to be fully repaid from existing contracts in place in fairly short order. Florida is a market where contracts generally require purchasers to make a substantial upfront cash deposit, when they sign the contract, typically in the neighborhood of 20%, and then to make progress payments on their contracts, as the physical construction advances, typically the first payment – the first subsequent payment is due when the podium is complete. Most projects today, especially on sea-facing beaches and so on, have a pretty tall podium to insulate the mechanicals and the residents, frankly, from storm surge. And then the last payment is typically made when the building tops out and that usually brings the cumulative deposit payments to between 40% and 50% of the purchase price. And at that level, that purchaser is quite committed to closing on the deal. So that’s how South Florida works, and we have one exposure there. We have some additional condo exposure in Dallas, Texas. That’s not a construction deal. That’s really an inventory or a bridge loan for a recently completed project, again, with substantial contracts in place, but not fully covered. The LTV is in the mid-50s. It’s a developer with which we have transacted before. It’s in a very strong micro-market in uptown/downtown Dallas. And then our final set of exposure is we have a small amount of condo exposure here in Manhattan in the – a little bit on the upper West side and some down in the sort of Gramercy Park, Madison Square Park area. And our basis there in these very well-established areas is very low. It’s materially below $1000 a foot. Which to your point about slowing housing sales nationally and in Manhattan, all of that is true and we observe that, although we’re not very active in the condo market anymore, we certainly observe it as homeowners. But at those exposures, that’s still considered affordable at least in the tri-state area. So we don’t have much exposure anymore, Greta has described very clearly what our strategy has been. That’s not to say that there may not be good opportunities in the future, especially in the condo inventory arena and that’s something that our team has a great deal of experience in. But it’s very market-by-market based, and it really requires probably some price adjustments, some further price adjustment in the market, which we’re watching carefully for, but frankly, haven’t seen in most markets yet.

And just to clarify a note detailed in some of your filings, but what is your total condo exposure as a percentage, if you include construction and non-construction?

It’s between 6% and 7% gross, and net of the contracts, it’s – this is rounded, but it’s about 1%. And there’s a pie chart in the supplemental that shows our gross exposure, then it shows the aggregate sales value of the contracts and then it shows our net exposure.

Okay. Great, thanks for going for that.

Our next question comes from Arren Cyganovich with Citi. Please receive with your question.

Thanks. Greta, you’d mentioned that assets are fully priced, not a big surprise. Maybe you can talk about what – which asset types you feel are, I guess, most at risk? Where cap rates are for those assets? And maybe where they could be from a stressed environments? And how that will affect your loans?

Well, we are seeing cap rate compression still in multifamily properties. We happen to like the fundamentals of multifamily from the fundamental growth we’re seeing in the operating performance, but we’re very mindful of stabilized cap rates, and we have seen those come in just because of the strong demand for that property type. I mean, frankly, all asset type seem pretty full in price today. We’re seeing some pockets of – I mean, I would say, retail is the exception. But the very good retail assets, there is a strong financing bid on it, I don’t know about the equity bid, but there’s still a very strong financing bid on the best retail assets. But for malls, in general, particularly, B malls and below, I – we keep seeing the same request from mortgage brokers, it looks like no one is biting on those. And retail is the main exception. We – cap rates same, they seemed pretty healthy right now from a – just being very low and supporting asset prices. So that’s something that we spend a lot of time on. We look at where the forward 10-year treasury curve is and can we refinance out of our assets given stabilized debt yields and particularly on multifamily.

I’d add another factor there. Greta described earlier some of the credit metrics for the portfolio. We don’t know exactly where cap rates might go, but originating loans that have loan-to-values of between 61% to 64%, 65% is thematically, we believe, a pretty defensive way to be active in this market, if you believe cap rates are at a cyclical low, which the data makes clear they are.

And I would just add that often, very often, when we are reviewing a loan and we felt – we like our loan basis, it makes sense, but I do not understand how the equity is going to make money at this purchase price. And – but if they have enough equity in, we can get our head around it, and to Bob’s point of having a 40% cushion, but we think the returns on the equity look pretty weak today.

Okay. Thank you. If the – one of the things that kind of stands out over the last three quarters is the yield on new investments, that spread has been bouncing around quite a bit. And I guess it just, kind of, highlights the differences of the mix that you’re putting forth each quarter. Maybe you could just talk about how it’s gone from I guess L plus 308, 403 and now the quarter-to-date investments are 339, what’s driving that variability? And how you’re thinking about the spreads generally overall?

Well, the difference between the second quarter and the third quarter is pretty striking. And it really is a result of – in fact, there was a loan that we thought was going to close in the second quarter, but it fell into the third quarter. So it happened to be wider-spread loan. So it skewed the second quarter and this gets to one of the things that we said in the past is it’s really hard to look at the lending business on a quarterly basis. It really needs to be over a longer period of time. But we are seeing for the – for Class-A apartments, just to pick a popular property type, spreads can be very tight on those. For other assets that are coming off a construction loan or there’s a big value add play, you can get a little more spread. So it really is the mix of what you are closing that quarter. And it’s also – we have recently been able to close funds where the borrower had a kind of the assets closing with hard money up, and they wanted certainty, and so when you’re in that situation, they go to tried-and-true lenders that they’ve dealt with over a long period of time and we’ve been the beneficiary of that. And that’s help us – has helped us achieve higher spreads in certain instances. So we love to see situations where borrowers have to close in a relative short period of time.

Thank you.

At this time, I would like to turn the call back over to management for closing comments.

Well, thank you all for your continued support, and we look forward to speaking to you next quarter, if not sooner. Thank you.

This does conclude teleconference. You may disconnect your lines at this time, and thank you for your participation.