TPG RE Finance Trust, Inc. (TRTX) Q3 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to TPG Real Estate Finance Trust Third Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah Ginsberg, Vice President, Secretary and General Counsel. Thank you. You may begin.

Good morning, and welcome to TPG Real Estate Finance Trust's Third Quarter 2020 Conference Call. I'm joined today by Greta Guggenheim, Chief Executive Officer; Matt Coleman, President; and Bob Foley, Chief Financial 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 and our 10-Q. We do not undertake any duty to update these statements, and we will also refer to certain non-GAAP measures on this call. And for reconciliations, you should refer to the press release and our 10-Q. 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, Deborah, and good morning. We are pleased to report our third quarter performance and the progress we've made since we last spoke. We realize there are a few distractions this week. So we will be concise, stick to what really matters and get right to your questions. Beginning with asset management, we collected 100% of interest due on our loan portfolio during the quarter. This includes PIK income of $3.3 million or 5.2% of total interest payments. At quarter end, we had 8 loans with partial PIK interest with an UPB of $526 million. This compares to 4 loans and $254 million at the end of the last quarter. Total loans modified with deferral of interest during the quarter were 4. Rent collections have declined slightly for our office loans to 91%, but remained steady at 92% for our multifamily loans. Hotel occupancy and RevPAR have steadily increased for each of our loans secured by hotel assets, with the best profits from our 2 resort properties, one that caters to the high-end market and the other, which is very much a mid-market property. As well, our select service properties have performed quite well. The office property in Brooklyn, securing our one office loan in that market was sold to a third-party, which happens to be an existing sponsor of TRT on other loans and our loan was assumed by the borrower. The VaR capitalized that asset with $13.5 million in new cash at closing and is expected to contribute another $5.5 million over the life of the loan. The new loan was paid down by $3 million and the borrower funded a 6-month interest reserve plus guaranteed interest for 9 months. We sold a $50 million mezzanine interest at no gain or loss in our largest loan on a Midtown Manhattan office building. The institutional purchaser is a JV of a well-capitalized and strategic investor. The VaR of the 7 property select service hotel portfolio that was 90 days past due at the last quarter, brought that loan current and also prefunded additional reserves for debt service. The VaR contributed $2.7 million to affect this. The underlying assets occupancy increased to 60% in October, and the property's RevPAR is approximately 67% of its 2019 RevPAR. Subsequent to quarter end, one loan has defaulted. This is a loan on 2 land parcels on the Las Vegas strip. The sponsor has substantial liquidity issues in its core business and defaulted R&R loan and requested a deed-in-lieu. We have rated this loan of 5 and have taken a specific reserve of $12.8 million on this asset. We received a 199 -- we received $200 million in repayments in the third quarter. Repayments year-to-date, including the payments received after quarter end, are $830 million. Additionally, we sold the aforementioned $50 million mezzanine loan, of which $3.6 million is a future funding obligation assumed by the purchaser. Our cash position increased to $226 million at quarter end and is $271 million as of yesterday's close net of covenant cash. We have unfunded commitments related to our existing loans of $194 million and $262 million for the next 6 and 12 months. Our expected net cash outlay on these fundings are $62 million and $84 million, respectively. With the exception of a $77 million A note financing our Las Vegas land loan, our nearest extended maturity of a secured credit agreement is April 2022. And with no corporate or FHLB debt, our liabilities are solely-secured credit facilities and CLO financings. Our weighted average fully extended final maturity on our credit facility is September 2022. After quarter end, we refinanced 7 hotel loans into a $250 million committed secured credit facility with a 3-year term with no mark-to-market for 2 years. As a result, 100% of our hotel loans are financed with no mark-to-market risk for 2 years, which brings our overall non-mark-to-market finance fees to 62.6% of total debt. Finally, our GAAP earnings per basic share was $0.40 and $0.39 per diluted share. Core earnings was $0.42 per share, reflecting our high asset level WACC of 4.96%. Had the aforementioned $250 million credit facility been outstanding throughout the third quarter, core earnings would have been $0.40 per share. We continue to work to demonstrate the value of our portfolio and believe that our assets most impacted by the pandemic still have meaningful value to our borrowers to protect and will provide significant upside in future returns, particularly since we are 7 months closer to the end of the health crisis. Lower initial LTVs and strong VaRs with high-quality assets have and will continue to serve us well. We continue to focus on liquidity, attentive and proactive asset management and extending the term and reducing the mark-to-market exposure of our liabilities. We believe in the book value of our assets, and our focus is on weathering the pandemic storm with our high-quality borrowers, so that we can realize on this value for our shareholders. We're also preparing to begin deploying cash in the new year. We're starting to see interest in lending opportunities as acquisition activity among our institutional sponsors has begun to gain momentum, albeit slowly. I will now hand the mic over to Bob Foley. Thank you.

Thank you, Greta, and good morning, everyone. We reported yesterday afternoon for the branding September 30, GAAP earnings per share of $0.40 GAAP earnings per diluted share of $0.39. And as Greta said, core earnings for the quarter ended were $0.42 per common share. That's up $0.19 per share from the prior quarter, due almost entirely to the absence in the third quarter of a loss we recognized last quarter on the loan we sold in June. We declared on September 15 and paid on October 23, a dividend per common share of $0.20. Book value per share increased quarter-over-quarter by $0.23 to $16.78 per share. On the strength of diluted earnings per share that exceeded our dividend by about $0.19 per share. For the past 2 quarters, core earnings have outstripped our dividend by an average of 1.63x. The primary drivers of our strong earnings were: first, that we collected 100% of our scheduled interest; second, LIBOR floors on 100% of our loans, all of which are in the money with a weighted average LIBOR floor of 1.69%; third, a quarter-over-quarter decline in interest expense of $4.4 million because LIBOR fell to 15 basis points from an average of 35 basis points during the second quarter, and that's a benefit that's magnified because only 8% of our liabilities involve non-zero LIBOR floors; and finally, our borrowings declined by approximately $123 million during the quarter. In terms of liquidity, cash on hand at quarter end was $225.6 million. And due in part to the $309.4 million of loan repayments that occurred in October, we have $140 million of cash in our CLOs awaiting reinvestment. Given the political, economic and public health uncertainties, we believe it's prudent for us to hold through the year-end higher than normal cash levels despite the short run earnings drag. It's an effective risk mitigant, and it positions us to selectively undertake new loan investments early in 2021. At quarter end, 54% of our liabilities were nonrecourse and not subject to mark-to-market provisions. Our 2 CLOs represent most of its non-mark-to-market funding. As loan repayments gain momentum, reinvestment features of our CLOs have and will continue to absorb more loans from our term secured credit facilities, further reducing our mark-to-market exposure. In the third quarter, we recycled $159 million across our 2 CLOs. We recycled another $110 million since quarter end, and we'll soon redeploy the $140 million of cash currently in our CLOs. When that happens, our non-mark-to-market liabilities will increase to 64.3% of our total debt, with one exception, our secured credit facilities are subject only to credit-based marks, triggered by non-temporary declines in underlying collateral value. We remain closely engaged with our lending counterparties. During the quarter, we borrowed $34.1 million from 5 separate counterparties. All are supportive of our business model and confident in the quality of our business platform, especially asset management and credit. After quarter end, we extended through October 2023, the initial maturity of one of our secured credit facilities. This was on the heels of 3 extensions during the second quarter, all of which serve to extend the maturity profile of our liability. Leverage remains low among the lowest in our peer set. Our leverage ratio at September 30 was 2.76:1, roughly 21% below our long-standing ceiling of 3.5:1. In terms of our secured credit facilities, we have also deleveraged. For example, our average approved advance rate against underlying collateral at quarter end was 69% compared to 78.7% at March 31 and roughly the same number at June 30. Across our 7 counterparties, we have a weighted average LTV on our pledge collateral of 66.6% and approved advance rate against that collateral of 67.8%, and thus, our lenders look through LTV to the underlying collateral is only 45%. Regarding CECL, at quarter end, our CECL reserve was $59.3 million or 109 basis points of our total commitments, up from 104 basis points to prior quarter end. Important factors influencing the quarter-over-quarter change in our reserve included a consistently cautious macroeconomic view that assumes that COVID-19 induced economic recession will continue into the second half of 2021. Although we're now 3 quarters into COVID, our underlying macroeconomic assumptions assume we stay in for at least 3 more quarters. The stable operating performance for many of our collateral properties was another important factor. In particular, the improving operating performance among many of our hotels. And finally, the $12.8 million specific CECL reserve we recorded against the Las Vegas first mortgage land loan. Our CECL reserve is the result of an exhaustive analytical process. It involves our entire business, and it represents our recent estimate of future expected losses based on our current knowledge of the portfolio and our expectations for the economy and the commercial real estate markets. And with that, we'll be pleased to take your questions. Operator?

[Operator Instructions] Our first question comes from the line of Stephen Laws with Raymond James.

Greta, I know you provided some comments on the asset in Las Vegas. Can you give us a little more color on expected time line towards reaching a resolution there, if you know that yet? I know, it's a couple of weeks in. And also, how much interest income, Bob, did that loan contribute in Q3 that we need to think about coming out now that it's on nonaccrual?

We're evaluating our options. We're proceeding to evaluate a foreclosure on the mortgage or the pledge of equity and also exploring a deed-in-lieu. I really don't know the timing. My sense is, given our strong security position and the borrowers, I think, willingness to move on, I think it could happen relatively quickly, but these things are unpredictable, and I can't really give you any assurances of that in terms of our getting control of the collateral.

Okay. And Bob, how much interest income did that asset contribute, if you know that number?

I'll come back to the group during this call. My computer has frozen up. So the schedule and calling up with that data on it, I can't quite access yet.

No problem. Greta, next question. You mentioned that, that type for new investments kind of in the new year, can you talk about opportunities and returns you're seeing there versus looking at some type of stock repurchase, given where the stock trades relative to book value? I know you cited confidence in the value of the portfolio during your prepared remarks. So I wanted to get your thoughts on how you think about new investments versus stock repurchase.

Yes. Well, this year, and certainly, in the third quarter and as we continue in the fourth quarter, there remains a high degree of uncertainty. There's still uncertainty over the election, and we're now in our second day of it. But the -- And in coronavirus cases, I read today have reached a new peak of 100,000. I mean, I -- at this moment, we still believe it's prudent to be defensive just given the uncertainty, we are hopeful that by the next time we all speak, there will be a vaccine and there will be a newly elected President with a lot of that uncertainty underway. And at that point, we'll evaluate the returns we can get on deploying our cash and -- versus considering a stock purchase. And we'll also look to see how it's helped other companies who bought shares, how that's impacted their share price and therefore, the return to shareholders, which is the main goal here is to maximize shareholder value.

Great. And you guys have made a lot of headway on the increasing of the non-mark-to-market financing. Is there a target percentage you're moving to or are there other loans? I know you've now got all the hotel loans financed with no mark-to-market for 2 years. But can you -- are there other assets you're specifically looking to do that or is there a target or how should we think about that number and where you'd like to get that in the next 6 months or so?

It's a very good question. It's very asset-specific. Our -- when we look at our portfolio, our multifamily assets have been very steady performance wise. And when you look at the investment sales market, in minimarkets other than New York City, Manhattan, you're seeing apartment projects trade at the same or even better levels than pre pandemic. So we're not as concerned about those assets, particularly maintain moderate leverage. We'll watch our office assets more quickly. We feel we don't have major valuation concerns on our office, and we can talk about our New York City office and explain why we're comfortable with that as well. But it's -- I guess to answer your question and not be so long winded. It is -- it's very asset-specific in general, having less mark-to-market financing is desirable, and we're going to continue to work on getting that higher, particularly as the CLO market looks like it's returning in terms of financing options. So we don't have a specific target in mind. In general, more is better, but it also depends on the asset side.

Great. I guess one last follow-up on that. But when we look at the recent financing at L plus 4.5% with the 25 bps floor, is that kind of the market now for that non-mark-to-market financing or is that specific because the line was designed for the hotel loans? And so therefore, a little higher expense. How do we think about that as we forecast our financing costs?

I think it was specific to hotel loans in the middle of a health pandemic.

And Steve, in direct response to your earlier question, the NIM, with respect to the Las Vegas land loan on a monthly basis, is approximately $420,000.

Our next question comes from the line of Steve Delaney with JMP Securities.

Congrats on the progress, and I certainly respect your caution on the current market. Curious if you could comment a little bit about repayments. You have seen some that's, I think, a positive $309 million here in the fourth quarter. Do you have some visibility looking out for the rest of this year and early next year, if there may be additional repayments coming beyond the $309 million that you cited?

It's the -- ever since the -- this health pandemic came on, we really spent a lot of time trying to understand, which of our loans would be in a position to repay in the third and fourth quarter. And the ones that we projected, we were pretty much, I would say, close to 100% accurate, and that really is because we have such great borrower engagement. The further out you are, it's a little less uncertain. But when you get within 90 and 60 days, you can have a little more confidence. We feel pretty good that repayments will continue. This year, they were -- they're expected to be slightly over $1 billion. Last year, they were $1.9 billion. I think going forward, it's going to be closer to what this year was, maybe plus or minus, and that's also just based on the age of some of our loans, too, because we did originate a bit in the fourth quarter of '19 and the early parts of the first quarter of 2020. So in the -- even pre-COVID, the average life of the loan was somewhere between 2 and 2.5 years. So given the combination of a still in a inefficient economy and some of the newer assets, I think it's going to be closer to this year's level.

Well, it would seem to me that as far as modeling, it would be prudent for us to assume that whether it's at year-end, the portfolio could shrink to somewhere in the neighborhood of $5 billion from the current $5.4 billion. And then maybe even though you are looking at new opportunities, it might -- is it possible that it might shrink further early in the year to something approaching $4.5 billion?

We're -- As I mentioned, we're seeing some interesting opportunities. So I think their -- countering that will be some asset growth.

Okay. All right. Bob -- Stephen asked about the cited the rate on the hotel loan. Are you -- as you look at that financing and you look at the interest that you're accruing on the properties. Is that still in a net positive, net interest spread situation or is it kind of a push at this point? It sounds like we need to factor in a slightly compressed overall blended NIM for the portfolio with the hotel financing, which, by the way, is a great accomplishment on the nonrecourse, no mark-to-market, right?

Thank you, and the whole team here did a super job on that very important financing. With respect to NIM, I think, and following up on Stephen's call, the cost of funds for that transaction clearly reflects the nature of the underlying collateral, which is hotels. I think there are some instructive comps in the market today. Several CRE, CLOs have been executed over the last month, some by public commercial mortgage REITs and other by private debt funds. And frankly, those weighted average spreads are in the pre-fees or in the 170 over LIBOR to, call it, 200 over LIBOR range. So there's a big range between those 2 endpoints. I think that for the rest of our financing costs in the rest of the space, you should be thinking more towards the low end of that range, but probably higher than the 164 basis points or so, that's our weighted average cost of capital. The capital markets have clearly shown some legitimate signs of recovery. That's been a cost-effective borrower, and we think that we'll continue to be that way. Obviously, getting more term is an important strategic objective, as Greta stated. And that sometimes comes at a premium, but it seems to be an increasingly modest one.

Okay. Just one final thing. And just to follow-up on Stephen's comment there. Cash, it sounds like you were going to stay high on cash, $250 million or better through the end of the year. As you get clarity on the economy, the election, all of this, at some point, if the stock remains in the 50% to 60% of book value range, do you believe that the Board would consider activating a buyback program?

I think they will consider all alternatives. As you can imagine, we've covered a lot of these alternatives year-to-date in numerous Board discussions. And you just really have to weigh how impactful is it to the stock price to do it and look at examples that are in the market where others have done it. And how -- as we -- you don't get that capital back and you also need to grow. So we'll weigh all of those various important considerations in coming up with the right decision, but the underlying fundamental goal will be what's in the best interest of our shareholder.

[Operator Instructions] Our next question comes from the line of Charlie Arestia with JPMorgan.

I appreciate that you guys disclosed the breakout of light-to-moderate transitional loan categories. With moderate at around 1/3 or so of the portfolio, just wondering how you guys are thinking about the future funding commitments on those loans. And I'm also wondering if that's where the most of the loan modifications so far have taken place.

In terms of the loan modifications, no, there's really not a great correlation to that category -- if the loan is falling into that categorization. The biggest correlation is how badly was that property type affected by the pandemic and which unsurprisingly is our hotel loans. And the -- as I briefly touched on in my opening comments, we have very moderate deferred funding. And frankly, we had none related to any construction loans. And the -- And we are also able to back lever in the 70% to 73% type of range on our preferred funding obligation. So it's really -- I think that is a relatively low number, I think, among the CM REIT peer set, the amount of deferred fundings we have. So it's not something that -- we have things we worry about. That's really not one of them.

Ms. Guggenheim, We have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Well, again, thank you all for taking time today. I know that there's numerous distractions as well as other important calls going on. And we thank you for taking the time, and we look forward to speaking to you at 3 months out when hopefully, it's a much better time for all of us. Have a great holiday season. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.