TPG RE Finance Trust, Inc. (TRTX) Q1 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the TPG Real Estate Finance Trust First Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Ginsberg, General Counsel. Thank you. You may begin.

Good morning, and welcome to TPG Real Estate Finance Trust's first quarter 2019 conference call. I'm joined today by Greta Guggenheim, Chief Executive Officer; and 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 the presentation of our operating results; all of which are available on our website in the Investor Relations section. I'd like to 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 results, please see the Risk Factors section of our most recent 10-K. We do not undertake any duty to update these statements. We'll also refer to certain non-GAAP measures on this call, and for reconciliations, I'd ask you to look at our press release and our 10-Q. 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 to all joining our call this morning. Our first quarter originations were very strong in terms of credit quality and yield. We originated $714 million in loans and increased our loan outstandings by 10% or $419 million. Loan balances from the first quarter of 2018 to the first quarter of 2019 increased by $1.1 billion or 31% year-over-year. The weighted average spread and loan to value of our Q1 originations were 396 basis points and 63% respectively. These 11 loans create an expected net return on equity of 10.8% and these returns will improve if there's a meaningful movement in LIBOR either up or down as our loans closed in the first quarter had a weighted average floor of 2.2%. Loans in the process of closing subsequent to quarter end totaled $614 million with a weighted average spread of 388 basis points. While it seems like a distant memory now, capital market spreads were significantly wider in the first quarter among the most all credit products with the possible exception of commercial real estate, single borrower CMBS transactions. We took advantage of the attractive yields offered by CRE CLOs and acquire 264 million of bonds, including $30 million of TRT CLO paper. Given our long career history as issuers and buyers of CRE securitized product, we're exceptionally well positioned to evaluate this paper. Also in 2018 TRTX was the largest issuer of CLO bonds, so we very much understand the structural nuances and differences among the various CLO offerings in the market today. In addition, we're familiar with many of the underlying loans and other issuers offerings as we reviewed them as potential originations for us. Our recent CLO purchases, were motivated primarily by the risk return proposition [indiscernible] offer. Well from time to time we purchased high rated short duration – from time to time, we have purchased high rated short duration CRE securities for cash management purposes and we'll continue to do so. We will buy investment grade shorter duration LIBOR based bonds for investment purposes, when the market offers unusually attractive returns as it did last quarter. Repayments in the first quarter were $271 million. We now project repayments to pick up in the remainder of the year and expect them to be about 25% of our portfolio in line with historic levels. This is based on discussions with some of our [Audio Dip] increases in their loan amounts and/or reduction in spread. While, we will refinance existing loans and increased proceeds when the underlying asset performance warrants it. We have declined to do so for assets that have performed at or below their business plan. In some cases, bars have retained for us to seek a refinancing that will provide higher proceed. Given the ample debt liquidity in the market today, we believe it is quite possible that many of these bars will be able to refinance elsewhere and increase their proceeds level. Let me emphasize, we are very happy holding these loans in even reducing the rate to keep them, but we are unwilling to increase proceeds if the cash flow does not justify it. On the credit front, our portfolio remains strong and we see no credit impairments on the horizon. Also a $67 million loan repaid in the first quarter that was one of three loans with a 4 rating at the end of the fourth quarter. We actively review and laser focused on credit for new loans and continue to prioritize cash flowing assets. The in place debt yield of our first quarter loan origination secured by income producing assets is 6.9%. By comparing in that measure was 6.3% and 5.5% for all of 2018 and 2017 originations respectively. Lastly, we raised a $119 million in common equity on March 19, with a $17 million green shoe exercise post quarter end. Given the volatility of the markets and the numerous potential catalysts for disruption, we access the equity market in Q1, so it's not to miss the capital raising opportunity this year. We have not found the convertible debt market particularly attractive and felt it was prudent to issue stock when we could add a premium to book value, granted, it was not a large premium. With the equity raise and organic funding sources through repayments, we are well capitalized to fund our portfolio growth. We are finding attractive investments as our first quarter performance a test by using the relationships of our team and the power of TPG's commercial real estate equity platform to find differentiated opportunities. With that, I will turn it over to Bob.

Thanks, Greta. Good morning, everyone. For the first quarter, we generated GAAP net income of $28.4 million or $0.42 per diluted share. Core earnings were $28.9 million or $0.43 per diluted share, compared to $28.6 million and $0.43 per diluted share for the preceding quarter. Our per share results were reduced approximately $0.01, due to our mid-March equity raise, which increased our share-based by 6 million shares or roughly 9%. Our results were driven primarily by net loan growth to $419.4 million, due to the closing of 11 loans with total commitments of $713.6 million and initial fundings of $633.1 million, deferred fundings on existing loans of $57.4 million and repayments of $271.1 million. For the quarter, our repayments were frontloaded, all of them occurred before February 6, while fully 70% of our originations occurred in mid-to-late March. Book value per share at quarter end was $19.73, compared to $19.76 at December 31, due primarily to the March equity offering, which we just mentioned. The quarter-over-quarter change in the mark-to-market value of our CRE debt securities portfolio was slightly positive, but did not materially impact our book value per share. The average risk rating of our loans was unchanged quarter-over-quarter at 2.8 on a scale of one through five. At quarter end, portfolio-wide loan level leverage decreased slightly to 71.3% from 72.8%. We expect leverage to increase as we closed the remainder of our $614 million loan pipeline. In the phase of moderating interest rate benchmarks in an inverted forward LIBOR curve, some of you have recently asked about LIBOR floors. We do insist on them and generally seek to strike them at a very near LIBOR at the time we close each loan. All but one of our 66 loans have floors, the weighted average floor for first quarter originations was 2.19% as compared to an average LIBOR during the period of 2.5%. These floors should preserve net interest income and periods of declining rates. By contrast, our liabilities are not floored, which has beneficial when rates decline. Our CRE debt securities investment portfolio increased by $233.8 million during the first quarter, due entirely to opportunistic purchases of 10 CRE CLO investment grade securities issued by five different collateral managers. We made a similar target investment play in CRE debt securities in the first quarter of 2016, when the CMBS market backed up. At quarter end, our third-party CMBS and CRE CLO holdings totaled $308 million or 6.1% of the total carrying value of our investments, which is not much different than the 5.4% metric at June 30 of last year. These CRE debt investments are liquid, provide solid income and can be converted into cash for deployment in the whole loans when appropriate. We remain committed to using non-recourse, non-mark-to-market, matched-term liabilities to reduce our borrowing costs and matched the tenure of our liabilities to our loan investments. At March 31, 45.3% of our liabilities provided matched-term, non-recourse funding for 42.4% of our loan investment portfolio. We recycled $31.8 million of capital when our second CLO that closed last November and just reinvestment period runs through November of 2020. Our first CLO, which we completed in February of 2018, currently, delivers low cost funding for $685 million of loan investments. At March 31, 2019, we repaid $247.4 million of the senior most bonds in the sequential pay structure, leaving 67% of the bonds outstanding. We expect to call the CLO later in 2019 depending upon the impact of underlying loan repayments on our advanced rate and our effective cost of funds. Favorable debt capital markets allow us to reengineer and rightsize our diverse portfolio of secured revolving repurchase agreements to further reduce our costs, improve our financing flexibility, and match the size of these committed facilities to a funding strategy that over the past 18 months has increasingly targeted term funding vehicles. We continue to explore various term funding alternatives to augment our existing CLOs in term loan funding arrangement. Doing so improves our competitiveness, enables us to be highly selective in our loan origination and sustains our asset level ROEs. At quarter end, our liquidity and capital base included cash of $55.4 million, $105.1 million of immediately available undrawn capacity under our various credit arrangements, the bonds previously mentioned, and $2 billion of available financing capacity under our financing arrangements. At targeted leverage of 3.5 to 1, our estimated capacity for new loan investments is approximately $1.1 billion. And with that Greta and I are happy to entertain your questions. Thanks very much. Operator?

Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Steve Delaney of JMP Securities. Please go ahead.

Good morning, Greta and Bob, and congratulations on a strong start to the year. You've been really consistent around this $0.43 core EPS level and 8.7% return on equity. I'm just curious, if there things that you can still do at the margin, obviously making attractive loans, but specifically to enhance that ROE level? Or do you feel that you're pretty much optimized at this point as far as your returns given current market conditions? Thanks.

Thank you, Steve. I think we have significant potential earnings growth and that really comes from full deployment of our capital and maximizing our leverage. I think, we entered the equity markets last year, sort of midyear and we did again recently in the first quarter for the reasons we mentioned. And I think – we are well capitalized now certainly for our 2019 and build that as we deploy capital, certainly with the high yields and strong credit metrics that we have found recently that we will be able to push that up. Now, of course a lot depends upon the level of repayments and market conditions. But we do believe that we just have not been able to optimize our cash positions in terms of having raised equity and with our normal organic repayment.

Got it. So you had been running somewhat below 2.5% debt to equity. Where could that simple debt to equity multiple, I think Bob, you also referencing a percentage, like 70%. So we can take the math either way. But where do you see that comfortably moving to?

Well, I think comfortably between three in a quarter and leverage ratio of 3 in a quarter to 3.5 times equity. If you look on Page 14 of our supplemental over the last several quarters shown what we think our sort of what our effective deployment is and what remains to be deployed before we reach what we define as fully leverage status, which is 3.5 to 1. Although, I think given the short term business plans that we're financing now that 3.5 could probably go up a little bit, but we've been consistently at around 80% the last couple of quarters, primarily because of the two factors Greta mentioned. Equity raises and repayments. Our ROEs as Greta mentioned, are typically in the 10%s. So if you just do the math, 80% roughly of our portfolio is earning 9.5% to 10%. We need to get the other 20% of our capital base deployed. Our dividend yield right now is 8.7%, right? So it all synced and that's the challenge and frankly, the opportunity ahead of us. But we've been able to achieve these returns, let's not forget, strengthen our capital base, increase our float, and still maintain very low LTVs in historical terms and in comparison to our competitors, very attractive spreads and what we think are appropriate risk adjusted ROEs. So I hope that answered your question.

Very thoroughly. Thank you both for your comments.

Thanks Steve.

Thank you. Our next question is coming from Stephen Laws of Raymond James. Please go ahead with your question.

Hi. Good morning.

Good morning, Stephen.

Hi Bob. A couple of questions. To start with maybe this quarter origination looks like the volume was strong again, but it consisted of a smaller loans and then more of those. Can you talk about, what you're seeing there in your pipeline and kind of what occurred during the first quarter that resulted in loans – a little bit below what we've seen as the average loan sized in the past?

Yes. If not that we're targeting lower loans or lower size loans, it's just one of our client base has. And one of our loans was a refinance. One was from a regular bar and all of where from powerful relationships that we have long-term relationships. We – like for instance, some of our smaller loans where hotel loans, we did know hotel loans in 2018 and that was an objective that we began 2018, well, I think it just happened that we didn't like the risk return metrics of them. And I think that for some reason hotels have become more attractive this year from a spread basis. And it's sort of what the market presented us this year, we – or this quarter. And it really is hard to judge us on a quarter-by-quarter basis. Last year, our average loan size was $124 million at last the fourth quarter. And this year roughly half that. So I think the real answer is it's hard to judge on a quarterly basis.

Yes, I think, Greta, I appreciate those comments and that's view and you know the follow-up on that, and it may be the same answer. But it looks like the new originations. Obviously, L+ almost 400 versus L+ 3 in a quarter – the prior quarter. Can you talk about spread of new investments? Is it a function of the mixed or maybe the hotel investments you referenced or is it less competition given the kind of rate outlook is now different than maybe last year when people expecting LIBOR to keep increasing?

Yes. I think last – in the fourth quarter, we did – I think our largest loan with also relatively tight and it just happened to fall in the fourth quarter. This quarter, I do believe that the hotel spreads in particular widened. And with the right leverage and the right sponsor, we were willing to add some hotels that remain 12% of our total portfolio. And so that certainly – probably, gotten the low end among our competitors. So we felt we did have room for them if we could find the right risk adjusted returns. I think one of our loans was from with an off market transaction from a sponsor that we have a 25 year relationship with, I hate to admit that. And so we were able to get a very attractive spread on that. It's really a testament to the strength of the platform in our relationship. One of our loans is in a market that we weren't targeting Kansas City. We dug into that market because our equity groups had spent a lot of time looking at the office market in Downtown Kansas City. So when a loan opportunity came in from Kansas City, we decided to spend time on it because we were very aware of equity group's investment desire. And we're at that time very familiar with a strong dynamic of the Kansas City market. It's a very strong office market and employment market. And it's one that is not as competitive as some of the other certainly top 10 markets. So because of that differentiated knowledge, we were able to jump on that and get a very attractive yield because not everyone was toppling for deals in Kansas City.

Yes. And lastly, and I apologize, Greta if I missed this in you're prepared remarks. But it looks like the balance of 4 weighted loans decreased from about $200 million to $133 million, that one pay off, did you reclassify alone or could you maybe touch on the decline in 4 weighted loans as of March 31?

Yes. One, $67 million loan that we have – has been rated number 4 at the end of the fourth quarter paid off in January. So that is the reason for the reduction there.

Great. Well that's being like a positive development. Thank you very much for your color on this questions.

Sure. Thank you.

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

Hey guys, thanks for taking my questions this morning. I just wanted to talk about the land loan in Las Vegas. Curious, given that project is in the idea that at least part of the property is going to be sold. If we should expect the duration on that loan to be a different from the rest of the portfolio. And then the other question is, was this actually a new transaction by the sponsor or is this an existing property that you guys have refinanced?

This is a new loan that we made for the sponsor. And, yes, as we have said, and you can tell from our portfolio, we focused on cash flowing assets and our debt yield of our portfolio as a whole is quite strong. This opportunity came up because of a long-term relationship with the sponsor and a very strong sponsor as well. And we didn't start the year saying, we need to do a land loans and it needs to be in Las Vegas. These parcels – these 28 acres are right on the strip. It's too large parcel. And it is – they're not creating more land on the Las Vegas strip. So this has definitely scarcity value with a sponsor that has very substantial cash equity invested in this project to the tune of $360 million cash investment. And our LTV, which we stress is 43%, certainly compared to the sponsor spaces. I think, also what got us comfortable with this loan, one of our regular, high quality multifamily sponsors has been trying to buy one of the parcels and their purchase price, which the seller has not accepted or did not accept when they made their offer would have paid off substantially all of our loan. And that's just one of the parcels. So there were many reasons we got comfortable with this parcel. But it was the cash equity, our basis per acre is also very favorable when compared to the trough recession land sales. And it is very favorable currently based on where a lands – nearby land parcels are selling today. Regarding the duration, it's an 18 month loan with one six month extension, and there is a required pay down at the end of the 18 months.

So Rick, compare that to – currently the weighted average life for loans in our portfolio, that has round tripped is between 2.4 and 2.5 years. This highly structured loan as Greta described has an initial term of only 18 months with the required pay down at the end of that. So we do expect this to have a shorter actual maturity then the typical loan in our portfolio. The other question was about tenure here and our borrower as Greta described, we've had a very long-term relationship with, he own this property for more than a decade. So they are extremely committed to it from a business standpoint and certainly from an economic standpoint given the size of their investment.

Got it. Okay. And the LTV is based on a mark to market of current values, not their cost basis?

Correct, yes. On a cost basis, it's 24% LTC.

Terrific. Thank you guys.

Thank you, Rick. Thanks for getting up early to join us.

Thank you. Our next question is coming from Arren Cyganovich of Citi. Please go ahead.

Thank you. This is Kelly Wang dialing in for Eric today. I'm wondering if you could comment on the general competitive landscape. Has it changed from what you've seen for the past few quarters? Also, I know you mentioned about hotel opportunities, but what are some of the other property types that you are seeing with opportunities.

Yes. It remains intensely competitive. We tend to do a lot of hotel, excuse me, multifamily property loans and I would say that's become the most competitive. And then office second in strong office market. So we have continued to see spreads come in and it is from non-bank lenders as well as bank lenders. But typically we're competing with the non-banks, the mortgage REITs and the private debt funds. So it is definitely competitive, but we do – it does feel like, on certain property types by hotel, that it has become a little less competitive. And I think it's because so many groups did a lot of hotel loans in the last two years. They may be full from a concentration standpoint. As I mentioned, we didn't know hotels in 2018 and we had numerous ones pay off. So we had room to take advantage of the possible widening. I don't want definitively say spreads have widened on hotels because you can be proven wrong very quickly with on a statement like that. But it does feel like we were getting better spreads in that factor in this quarter then what we were witnessing last year.

Great. Thank you.

Thank you, Kelly.

Thank you. At this time, I'd like to turn the floor back over to management for closing comments.

Well, thank you all for calling in. We're very excited about the progress we've made in terms of our liability and our asset structure. And are encouraged despite the competitive headwinds for the rest of the year. Thank you.

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.