TPG RE Finance Trust, Inc. (TRTX) Q3 2019 Earnings Report, Transcript and Summary

Greetings. Welcome to the TPG RE Finance Trust third-quarter 2019 earnings conference call. [Operator instructions] Please note that this call is being recorded. I will now turn the conference over to your host, Deborah Ginsberg. You may now begin.

Good morning, and welcome to TPG Real Estate Finance Trust third-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 a 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 results, please see the Risk Factors section of our most recent 10-K. We do not undertake any duty to update these statements and will also refer to certain non-GAAP measures on this call.

Thank you, Deborah, and good morning to all. We had a strong third quarter with GAAP and core earnings of $0.44 and $0.45 per share, respectively, and portfolio growth of earning assets to $5.7 billion. This growth was achieved due to strong originations of $805 million during the quarter, which outpaced repayments of $512 million. Our originations continue to grow year over year and are $2.3 billion versus $1.9 billion for the same period last year. Our earnings reflect our ability to source loans that adhere to our credit parameters, our continued focus on investing our cash and our ability to reduce our cost of funds. As well, we have been successful in obtaining interest rate floors. $2 billion of our loans have LIBOR floors between 1.8% and 2.5%, and the weighted average floor on our year-to-date originations is 1.93%. Our weighted average spread for the quarter was 289 basis points over LIBOR. However, I'd like to point out that roughly half of these originations have floors that are, on average, over 20 basis points above current LIBOR, meaning they are in the money. The third-quarter weighted average LTV is 70% and our portfoliowide LTV is 66%. This LTV reflects the fact that we have only one construction loan. Having a high percentage of construction loans, which we do not, results in a lower overall reported LTV as the initial loan amount on construction loans are usually a small percentage of the total loan amount as compared to typical transitional asset loans. Presently and subsequent to quarter-end, we have $475 million of loans closed and in the process of closing with a weighted average spread of 305 basis points and a weighted average LTV of 60%. We continue to be extremely focused on building and maintaining a portfolio with the strongest credit characteristics possible and focus on the most downturn resilient property market and loan type. We are not targeting hotel and construction loans as they are more vulnerable to negative macroeconomic environment. Office and multifamily properties represent 70% of our portfolio, and we're 100% of our third-quarter originations. As well, we have continued to focus on properties that can be stabilized in less than two years and have significant in-place cash flow or will have in the very near term based on the property lease-up to existing current market occupancy and rent levels, not pro forma levels. Loans collateralized by office properties represent 45% of our portfolio. Regarding office properties and issues potentially affecting their performance, there has been a lot of discussion on We Company. So let me hit this directly. We have minimal exposure to We Company as these leases represent 1.4% of our total portfolio square footage and 2.9% of our office assets rentable square footage spread among three loans. The largest exposure as a percentage of our collateral square footage is in a Class A, Midtown Manhattan office building. The We Company lease represents 25% of the building's total rentable square feet and encompasses 126,000 square feet. The We Company leased again in early 2017 and due to strong demand was twice subsequently expanded. The lease is currently -- the space is currently 95% occupied including this newest expansion space of 24,000 square feet, which opened in August of this year. We have analyzed each property assuming We Company leases are terminated and are very comfortable with our basis. Each of the loans with We exposure has excellent sponsorship and very substantial invested equity. 100% of our loan portfolio is performing and we believe of excellent quality. Our overall risk rating at quarter-end of 2.9 is slightly above last quarter's rating of 2.8. The increase is the result of our policy that we start all loans originated in the quarter with a three rating. An exception to this policy is if we have refinanced an existing TRT loan that had and still deserves a superior rating. Given we had new originations of $805 million in the quarter, which were automatically rated a three pursuant to our policy, and we had repayments of $512 million, which were rated on average 2.4, our overall rating increased. But please note that our loans with a four rating declined by $69 million due to repayments. We are extremely pleased with our portfolio and our quarterly performance despite the earnings headwinds of LIBOR having declined from 2.4% at the beginning of the quarter to 2% of the end. LIBOR has continued its decline post quarter-end, and our floors will show their work during the next couple of quarters. Our portfolio remains a very high quality. We continue to deploy our cash efficiently, and our pipeline is strong as we enter the year-end and 2020. With that, I will turn the call over to Bob.

Thank you, Greta. For the third quarter, we generated GAAP net income of $33 million or $0.44 per diluted share and core earnings of $33.4 million or $0.45 per diluted share. On a per-share basis, both increased $0.01 versus prior quarter. We declared a dividend of $0.43 per share, covered approximately 1.05 times by our core earnings. Earnings growth was driven primarily by an increase in net interest margin of $2.7 million quarter over quarter, largely due to the earn-in of our $755 million of originations during the second quarter, yield maintenance and unamortized origination fees from certain loan repayments and investment earnings from our short-term investment portfolio. Net loan growth of $187.4 million was driven by the closing of six first mortgage loans representing total commitments of $805.3 million and initial fundings of $654 million, deferred fundings on existing loans of $45.2 million and repayments of $511.9 million. For new loan originations, the average loan size was $134.2 million, an increase of 42% over the prior quarter. Our weighted average credit spread was 289 basis points as compared to 364 in the prior quarter, and the weighted average LTV was 70.1%. The weighted average spread of our loan portfolio at quarter-end was 365 basis points, compared to 377 basis points at June 30 due to the repayment of older vintage loans with wider credit spreads and the origination new loans with tighter credit spreads reflecting current market conditions and our risk preference for loans with more in place cash flow and less lift during the loan. For our third-quarter originations, the weighted average asset level ROE was 9.2%. At quarter-end, portfoliowide, our loan level leverage was virtually unchanged from the prior quarter at 76% versus 77%, and our overall debt-to-equity ratio was also virtually unchanged at 2.9 to one versus 2.90 to one. Book value per share grew quarter over quarter by $0.02 due primarily to earnings in excess of dividends paid, the sale of certain short-term investments with estimated fair values less than par and unrealized gains on our other short-term investments. Our capital markets team had a very busy quarter, executing on our never-ending strategy to reduce exposure to mark-to-market risks, term out our liabilities and reduce our borrowing costs. In mid-August, we redeemed, as planned, our first CRE CLO, which was issued in February of 2018, since the repayment of loans underlying the issue of liabilities render the transaction materially less efficient than other forms of term funding available to us. Also in August, we closed a new $750 million secured revolving repurchase agreement with Barclays, thereby increasing our loan repo and warehouse financing capacity to $4.125 billion and a number of such counterparties to seven. That facility has an initial term of three years with two one-year options to extend and contains the normal TRTX mark-to-market provisions that limit trigger events to collateral-specific matters. We continue to amend existing credit facilities to capture more attractive economic terms, and we removed from a term loan facility about $269.7 million of loans that were largely slated for inclusion in TRTX 2019-FL3, which gives us the same risk mitigation features but at a lower cost of funds. And last but not least, we settled last Friday on the largest CRE CLO issued to date, a $1.2 billion transaction with a two-year reinvestment period, an advance rate of 84.5% and a weighted average spread of LIBOR plus 144 basis points before transaction costs. Today, more than 50% of our liabilities are term-funded, non-recourse to TRTX and involve no mark-to-market provision. And you'll continue to see more from us on this front. We utilized the reinvestment feature of FL2 to recycle approximately $168 million of loan repayments received during the quarter. Year to date through September 30, we recycled $269.2 million of capital, and we expect to recycle low-cost non-mark-to-market capital in both of our current CLOs through the end of their reinvestment periods, which are November 2020 and October 2021. We disclosed this quarter the status of our work to implement CECL, a new accounting pronouncement that will take effect on January 1 of next year. CECL will materially change how lenders determine and disclose their allowance for losses on financial assets not reported at fair value. CECL requires lenders to record a credit reserve based on forecasted losses over the life of the loan. With the exception of riskless assets like U.S. treasuries, CECL presumes losses for all financial assets, including moderate LTV first mortgages on institutional quality properties such as the loans we originate. Accordingly, we expect to record a CECL reserve. Our initial reserve assessed against our entire loan portfolio balance at year-end will be recorded effective January 1 as a reduction in equity. Changes in our CECL adjustment and subsequent quarters will flow through our income statement and equity accounts. Important factors influencing the CECL reserve will include the size of our loan portfolio and its risk profile; actual losses incurred, if any; and current and projected future conditions in the commercial real estate markets and the macro economy. At year-end, we'll provide more detail to you about our CECL methodology, our reserve and our implementation progress. And with that, we'd be happy to take your questions. Thank you very much. Operator?

Thank you. [Operator instructions] Our first question is from Steve Delaney with JMP Securities. Please go ahead.

Thanks. Good morning. Appreciate you taking the question. I'd like to start with the weighted spread on new originations. We look back to the second quarter. 365 basis points was pretty much right on the portfolio at 370. So I was wondering if you could comment -- 290. And Greta, we heard what you said about 20 basis points in the money. So even if we add that back, it would be like 310 versus -- down 50 or 60 basis points. Was there anything in the mix? We noticed it was heavy office. Anything in the mix that would attribute that shift? Or are we just basically talking about a change in market pricing? Thank you.

I think this quarter, roughly 80% of our loans were in gateway markets, and the sponsorships are much more institutional the larger the assets and it's just more competitive. We really have dug in and focused on credit just given what's going on in the world economy. Not that we haven't always dug in on credit, but this quarter -- we've always said it's a little bit lumpy. We happen to have some two very large loans, as Bob mentioned. Our weighted average loan size went up and these were sub-300 spreads. I mean when I look at our pipeline for next quarter, we're slightly above 300. But yes, it's a combination of factors. One, it's just how the dice rolled in terms of what closed during the quarter. And two, spreads are tied particularly for the gateway markets.

That's helpful. And you made a comment on floors. I was looking where LIBOR was 240 at the end of 2018, it's down to 180. And maybe we have a couple more cuts, who knows? But it seems like -- I'm not trying to put words in your mouth. But is it -- let me ask it this way. Is it logical to think that when LIBOR has already declined materially that your ability to negotiate floors that are flat to the entry rate is easier to accomplish than if LIBOR was 2.5 or three and the borrowers are praying for 100 basis points of relief?

Yes. I think that's a fair comment. It's easy. Typically, historically, we would regularly negotiate 25 basis points below the current LIBOR. And for some borrowers, they would push even further than that. But now, it's much easier to get as close to in the money as possible because it's so low. And I think what it feels like is that the industry is gravitating to what the insurance companies have long done and that is just have minimum coupons regardless of where the index is. And it feels like that a little bit. I hope it's true.

OK. That's helpful. And the last, kind of a more big picture. Portfolios up to -- funded portfolio at $5 billion. And if we assume a couple of hundred in the fourth quarter, it puts you at $5.2 billion. That would be $900 million or about 20%, 21% growth year over year from year-end '18 to '19. As you look at conditions and you look out to 2020, do you see 2020 as being a year where you can continue to grow your portfolio 10%, 15% consistent, I guess most importantly, with your current underwriting standards and the level of competition? That's it, and I appreciate your comments.

Yes. I mean every year at this time and up through January, like, oh my gosh, it's going to -- how are we going to make this production? Yet we have consistently increased. And I don't see any conditions in the marketplace that would prevent us from doing so. Now that being said, it is an election year and we could have some tumultuous activity in the market depending on how that unfolds. And also with the macroeconomic and geopolitical world, there could be some shots. But based on what we see now, yes, I would expect our portfolio to continue to grow.

Thank you.

Thank you. [Operator instructions] Your next question comes from Stephen Laws with Raymond James. Please go ahead.

Hi, good morning.

Good morning, Steve.

Greta, first, looking at the portfolio, it looks like from comparing the Qs that you had the four-rated loans secured by the Atlanta retail payoff, I believe. Can you maybe talk about that? Was it expected? Maybe talk about the conversations with your borrower leading up to that. And then if you can provide any details on the Woodland Hills retail loan, it looks like you guys moved to four this quarter, that would be great.

Sure. Well, the Atlanta asset did repay due to a sale of the asset by the sponsor. This was one where I would say that what we refer to as our broken window policy, referencing Police Commissioner Bratton during the Giuliani years, our policy toward asset management really worked. This asset very -- we had a great sponsor with substantial equity invested and that's what attracted it to us, and it was in a great part of Atlanta in the Buckhead market so very infill. Yet almost from when we closed it, the new leases signed did not meet their pro forma leasing and the rental rates they were achieving were off significantly. And this really reflects what we saw nationally in the retail landscape. And we were very much on this loan, definitely weekly. And what we were able to do because of provisions in our loan agreement was if they wanted to sign a lease below what the leasing guidelines indicated, they actually had to pay the loan down. And so we got a little bit of a pay-down every time they signed a lease, which got them more and more invested in the asset, which new -- which is our goal so that they will always protect. So given that it was a retail asset, of course, it was one that we would worry about relative to other property types. That's why you don't see a lot of retail in our portfolio, but we had an excellent sponsorship. I think they always would have done the right thing anyway, but you need a little protection by having the right provisions to require them to commit capital as their business plans are not being met. And then the asset that was added to four is the retail property in a great infill location in California. It is -- it has not met its business plan. It's also a small loan at $33 million but it's with a repeat borrower that we've known for many years. And they have held out for a certain type of tenants, which has resulted in them being with a very low occupancy relative to market. The markets closed at -- is 95% occupancy for comparable properties, ours is at 45%. And I think he is just holding out for better chance. It's a great type of retail and he's just repositioning it for higher-end tenants.

Great. Appreciate the color on those two loans, Greta. Bob, on the financials, can we maybe talk -- are there any early repayments or prepayment fees in the third quarter? Was it a normal quarter from that standpoint? Or how should we think about the early repayment fees?

Well, as you saw, we had about $512 million of repayments. In connection with a couple of those, we -- one of which we paid slightly earlier than we expected. We did have some unamortized origination fees and a yield maintenance payment. We also had some costs, frankly, associated with the financing of that asset. And we also incurred some costs in terms of some of the other financing activity that we did during the quarter. So net-net, the impact on our earnings was not that material. Most quarters will have some very modest amounts of yield maintenance or accelerated recognition of origination or exit fees. But generally, those amounts aren't material and they're fairly consistent.

OK. So nothing -- no outliers this quarter from...

No major outliers this quarter.

And then I think you may have kind of hinted at it in your comments there. But as we think about the CLO that just priced, any expenses that maybe were in the third quarter that elevated expenses? Or will we see those hit in Q4? And how do we think about redeployments? I know that vehicle is more efficient from a capital standpoint. So redeployment and others update on the Subsequent Events section looks like about $75 million, $70 million of net funding in October. But can you maybe help me think about my model and how I should think about the pluses and minuses of redeploying that capital from the CLO transaction, the expenses coupled with that?

Sure. Let me attack the second portion of the question first and then I'll hit expenses. With respect to recycling of capital in both CLOs, the team here is really focused on that. Sort of like being a landing officer on a carrier, you need to time the closing of your new loans that you want to go into the CLO in whole or in part to happen as close in time as possible to the repayments. Repayments are clearly much more challenging to control because the borrower controls them. But we've got a lot of experience here and a really strong team, and so we try to line those up pretty quickly. But you should generally assume that loans that we originate, they might get warehoused for a short period of time on a repo or other facility. But the liabilities of these CLOs are really attractive not just from a cost standpoint but in terms of non-mark-to-market and non-recourse in term. So we want to use those first, and we will. So that should be your decision when you think about modeling the company's results, or I would recommend that that be your decision rule. With respect to your question about expenses, these transactions, as I mentioned before, are not inexpensive. But even on an all-in, fully amortized basis, the cost of funds is extremely attractive. It is -- the premium one pays for term funding these liabilities is very small in comparison to repo financing. And it's cheaper, frankly, than some other term funding financing that we've executed frankly or that we've observed some of our competitors execute. Most of the costs are deferred and amortized over the life of the deal. I mentioned that we did move some collateral around in order to -- among our existing credit facilities to position them for inclusion in FL3. And there are some deferred financing costs related to where those loans were previously financed that is expensed during the quarter and that was expensed during the third quarter, but in the aggregate, not material.

Great. Thanks, Bob. Thanks very much for your comments.

Thank you.

Thank you. Your next question comes from Rick Shane with JP Morgan. Please go ahead.

Hey, guys. Thanks for taking my question this morning. Is the portfolio processed into the $5 billion range and we're starting to see sort of a more steady state of repayments? I'm curious, where do you think equilibrium in terms of portfolio size, in terms of your ability to originate and balance repayments sort of creeps into the picture?

I think regarding repayments, I think this year, at least for us, feels like it's going to be somewhat higher than it has been historically. As a percentage of commitments, our repayment, at the end-of-year commitments, our repayments are not really an outlier. I mean we have had precedent in prior years but it is on the margin higher. I believe it's a result of the fact that we still have some pretty good credit spreads on our portfolio and borrowers are taking advantage of lowering their floors potentially and getting tighter spreads. And the mortgage broker community is exceedingly active to try to talk borrowers into refinancing bridge loans with bridge loans. So that's how they churn their fees. So hopefully, the repayments will decline in next year and the future but we don't have a perfect projection for that. And I think that our originations will continue to increase. They have increased every year. And we expect them to, just based on the pipeline we see and the loan activity that we're seeing. And this last quarter, we were successful in increasing our average loan size. And I think that will also help as we continue to do that to continue to grow the portfolio. So where do we stabilize? I mean it's a lot more than where we are now. I mean we all look at Blackstone as the beacon. So I think that's certainly a possibility. And we're just making sure that our growth is prudent and from a credit perspective and accretive, and we will not grow for growth's sake.

Got it. Look, you guys have proven to be disciplined over time and we've all known each other a very long time. And I think that's the hallmark of the entire team. Greta, you touched on something interesting, which is that one way to continue to scale the business is through larger loan size. And that makes sense as the balance sheet expands and your ability to fund those loans increases and the concentration risk diminishes. What are the trade-offs that you see associated with making larger loans?

Well, from a risk management standpoint, we're very mindful that our weighted average loan size stays within a certain range of our equity base. And so that's one thing we're very mindful of. That's first and foremost. The trade-offs have historically been spread because you are competing with the securitized single-borrower market. Then we're competing with -- more directly with Blackstone and Brookfield and the players that go after Uber-large loans. But we're not -- certainly at this stage, we're not going to take on the loan sizes that we see those players doing. We had -- the largest loan we've done is $350 million. That's pretty big for us. So I think the $150 million to $200 million is a perfect size for us and keeps us out of the size of the big guys that are really going exceedingly tight on their spreads.

Right. Thank you guys for taking my questions this morning.

Thank you, Rick.

Thank you. We have reached the end of the question-and-answer session. And I will now turn the call over to Ms. Guggenheim for closing remarks.

Well, thank you all for joining us today. We're very excited to close out the year and begin 2020 in a new decade of origination and growth.