TPG RE Finance Trust, Inc. (TRTX) Q2 2021 Earnings Report, Transcript and Summary

Good day, and welcome to the TPG Re Finance Trust Second Quarter 2021 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the conference over to Deborah Ginsberg, General Counsel. Please go ahead.

Good morning, and welcome to TPG Real Estate Finance Trust's conference call for the second quarter of 2021. I'm joined today by Matt Coleman, President; Bob Foley, Chief Financial Officer; and Peter Smith, Chief Investment Officer. Bob and Matt 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 discussion of some of the risks that could affect results, please see the Risk Factors section of 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, I will turn the call over to Matt Coleman, President of TPG Real Estate Finance Trust.

Thank you, Deborah, and thanks, everyone, for joining the second quarter earnings call for TRTX. I'm happy this morning to be covering another strong quarter for the company. As I've done over the last few quarters, I'll frame today's discussion along the dimensions of the 3 key strategic pillars that I first articulated at the beginning of the year -- capital structure optimization, renewed originations and portfolio performance, consistent with proving out our book value. But first, I will begin with a brief update on our CEO search. TRTX's Board of Directors and representatives of TPG have established a search committee and retained an executive search firm. The committee's work is ongoing, and we expect to have further updates for you over the coming quarters. Now, turning to our second quarter results and starting with capital markets. We redeemed in full all $225 million of the company's outstanding 11% Series B preferred stock, using a combination of cash on hand and the proceeds of a new $201.3 million issuance of 6.1/4% Series C preferred stock. We were able to take advantage of very robust capital markets, lowering our preferred dividend rate by more than 43%. This issuance, together with our $1.25 billion CRE CLO that closed on the last day of the first quarter, puts us in a very competitive position with respect to our overall cost of capital available for new originations. As a result of the new second quarter originations that I'll cover momentarily, we've also fully utilized the nearly $309 million ramp feature of that CLO. Midway through the year, we're proud of our capital markets achievements, including the fact that now 82% of the company's debt obligations are non mark-to-market. Moving now to new originations. Activity in the second quarter was robust. We closed 9 loans, representing more than $750 million of commitments, focused on multifamily, which was 45% of the total; and life sciences, approximately 44% of the total. Taking into account signed term sheets after quarter end, we're now at more than $1.1 billion of originations year-to-date, and our total loan portfolio grew 6.7% quarter-over-quarter to more than $5.3 billion. As always, the relationships, connectivity and intellectual capital resident within TPG broadly, and TPG Real Estate more specifically, afford us competitive advantages in sourcing, market selection and asset-specific insights. As of the end of the second quarter, we continued to have substantial additional available liquidity of nearly $400 million, which we can use to fuel future originations and portfolio growth. Finally, turning to our portfolio. We had interest collections of more than 99%, including 1.1% of PIK for the quarter, with the only non payer being the defaulted retail asset in Southern California. We're in the process of marketing that asset for sale and hope to have a further update in the reasonably near future. With respect to our owned real estate in Las Vegas, we have selected a sales broker and are beginning to have discussions regarding the disposition of both land parcels. We expect to have updates with respect to Las Vegas over the coming quarters as well. During the second quarter, we had nearly $400 million of realizations, largely in the form of loan repayments, including more than $290 million of office exposure across 3 loans and an additional $32 million mixed-use loan consisting of both office and industrial. We also opportunistically sold one hotel loan, which reduces our hotel exposure by approximately $60 million and will enable us to redeploy that capital into other assets, more aligned with our current objectives. At quarter end, traditional office, excluding life science, represented approximately 44% of our portfolio. Life science represented 9% and hospitality was down to 12.7%. In general, we saw strong performance across asset classes, including improved hotel performance. Accordingly, risk ratings were stable quarter-over-quarter, and we released approximately $3.5 million of CECL reserve, generally reflecting a continued improving macro environment. In the midst of this good performance, we are, of course, paying close attention to the spread of the Delta variant and the effects it may have on the U.S. economy. With that, I will turn it over to Bob to cover our financial results for the quarter.

Thanks, Matt, and good morning, everyone. We reported yesterday for the quarter ending June 30, 2021, GAAP net income of $32.4 million, a net loss attributable to common stockholders of $21 million or $0.27 per diluted share and distributable earnings of $21.9 million or $0.27 per diluted share. That represents 1.41x coverage to our current common dividend and 1.17x coverage to the sum of our current common dividend, plus the pro forma run rate quarterly dividend on our newly issued Series C preferred stock. Net interest margin increased quarter-over-quarter by $2 million, despite loan repayments of $334 million. Book value per common share declined quarter-over-quarter to $16.03 per share or $0.58 due almost entirely too onetime charges of $45 million incurred in connection with the redemption of our $225 million Series B preferred stock that we issued in May of 2020. Our CECL reserve declined by $3.5 million or $0.04 per diluted share in response to improving domestic macroeconomic outlook that informs our loss given default model, continuing improvement in operating performance across our loan portfolio and especially among our hotel loans, which now represent 12.7% of our loan portfolio, the sale of a $60.7 million performing hotel loan and a decline in our reserve rate to 104 basis points from 118 basis points. Book value per common share before giving effect to our CECL reserve was $16.75 per share versus $17.37 per share in the first quarter. In summary, in terms of net income from operations before the Series B redemption, our second quarter 2021 operating performance surpassed the first quarter. Capital structure optimization remains the singular focus of our capital markets team. In June, we raised net proceeds of $194.4 million by issuing perpetual preferred stock at a sector-leading low dividend rate of 6.1/4% and immediately redeemed $225 million of the 11% Series B preferred stock issued in May of 2020. We slashed our coupon cost by 43% and replaced temporary equity with permanent equity redeemable at our option after 5 years. We made a onetime cash make-whole payment of $22.5 million, and we wrote off unamortized warrant fair value and transaction costs of $22.5 million. More detail regarding this important transaction is contained on Page 16 of our earnings supplemental. When paired with our highly cost-efficient debt capital base, we're now well positioned to grow our loan portfolio, as we've demonstrated thus far this year by originating $1.1 billion of first mortgage loans and registering net loan growth in the second quarter of $335 million. At quarter end, our stable debt capital base was 82% non mark-to-market and 77% matched-term funded with CRE CLOs, both sector-leading levels. To further extend the term structure of our liabilities, after quarter end, we extended for up to 3 years, a $250 million secured credit facility with Goldman Sachs, one of our 7 lender counterparties. Lower cost, longer-term liabilities are a key ingredient in our ability to originate quality first mortgages at modest loan to values. At quarter end, our weighted average as-is LTV ratio was 66.7%, virtually unchanged from the prior quarter. And we continue to explore other forms of secured and corporate financing, we believe, will be accretive. Risk ratings remained unchanged at 3.1% quarter-over-quarter with positive migration and risk trends. We upgraded to 3 from 4, our 2 operating resort hotel loans based on strong operating performance and a 4 loan single-borrower residential condominium financing to a 3 from a 4, based on improving market conditions and progress against the business plan. One office loan was downgraded to a 3 from a 2 due to slow leasing activity. Repayments included 3 office loans and one mixed-use loan with a weighted average risk rating of 2.9. And as mentioned earlier, we sold one hotel loan, which was rated a 4. We collected 99.3% of scheduled interest. Our PIK balance at quarter end was only $4.2 million, a reduction of $1.4 million quarter-over-quarter. We expect further reductions in the second half of this year, since only one of our loans is currently picking, and all of our modified loans are performing. At June 30, cash on hand for investment was $224.7 million plus undrawn availability on our credit facilities of $99.5 million. Reinvestment capacity in our 2 CLOs is tied directly to the volume of loan repayments, which are returning to pre-COVID levels. At quarter end, we had $53.8 million of CLO reinvestment capacity immediately available after reinvesting $72.2 million during the quarter. Unfunded loan commitments were $488.9 million, only $9.2 million of our total commitments, which reflects our continuing emphasis on loans with business plans that can be quickly achieved, involve modest future funding requirements and enable us to achieve a high utilization rate with our shareholders' capital. At quarter end, our debt-to-equity ratio was 2.44:1, a decline of approximately 1/3 of a turn of leverage due to the timing of loan repayments versus new originations and our decision to hold unleveraged for a short period, approximately $70 million of loan investments. Our current capital base can support substantial growth in earning assets. Based on a target debt-to-equity ratio of 3.75:1, which we believe is appropriate, given our very high proportion of non mark-to-market term borrowings and a current equity base of $1.4 billion, total earning assets could reach $6.5 billion. To recap, we delivered during the second quarter, strong performance in operations, capital markets and credit. In fact, we outperformed the preceding quarter. Net loan growth was $335 million on the strength of $753 million of new originations, offset by resurgent loan repayments of $358 million. We have a strong loan originations pipeline. We have a healthy distributable earnings coverage of 1.4x our current common dividend rate, and we have significant capacity for growth supported by current -- by our current capital base. So with that, we'll open the floor to questions. Operator?

[Operator Instructions]. We'll take our first question from Don Fandetti with Wells Fargo.

I was wondering if you could talk a little bit about what you're seeing in the real estate debt and equity markets in terms of delta, if investors are making changes? How you're thinking about it? And what part of your portfolio are you watching a little closer?

It is something that we're certainly paying attention to. We're seeing, I think, the beginnings of the intersection of public policy and public health as federal, state and local governments think about how to best attack this. That being said, I think it is reasonably early. It is, in all honesty, a little hard to tell. We're not -- I think, as it relates to our portfolio performance at the moment, we're frankly not seeing negative impacts. However, it is concerning, I think, as we think about return to office. And people had been thinking, I think, about after Labor Day as a real bellwether indicator for what return to office might look like broadly. It certainly raises some questions, and it is something that we're paying close attention to. Although as I said, we're not currently seeing direct measurable negative impacts on our portfolio or performance.

And then can you talk about what market the one office loan was downgraded and also why you sell the hotel loan?

Sure. That one office -- that one office market is Orange County, and we just saw a slowdown in leasing. So that was a move from a 2 to a 3. The hotel loan, I think, presented an interesting opportunity with a pending maturity. We were able to achieve a dollar price of $0.98. And while there was not a specific CECL reserve against it, the impact on releasing reserve was quite positive and on a net basis, accretive to book value. And so, it was a good opportunity to execute at very attractive price.

We'll take our next question from Tim Hayes with BTIG.

My first one, just spreads on new loans this quarter were a bit wider than the portfolio average, despite you guys focusing on some more stable asset types, where there -- I would assume there's more competition. 2 of the 3 loans you highlighted in the deck were bridge loans, and there was that one moderate transitional loan you highlighted. But were the other 3 largely moderate transitional or construction loans? I'm just curious how you're able to get a bit wider spread and a LIBOR floor above where spot LIBOR is, while focusing on more defensive asset types?

Sure. Why don't we have Peter address that?

I think what we're seeing in the quarter is -- really just a continued sort of focus on being selective on the deals -- and the deals that we're seeing. We are seeing a lot of opportunities in areas right now. And generally, we had -- in the first and second quarter, we really had a lot of capital to invest and we're focused on really getting money out on deals quickly that we liked and that we wanted to compete a little bit heavier. We're being a little more selective right now. As Matt had pointed out, we're about $1 billion, $1.2 billion into the year, well on the way of achieving our goals for the year. So we're -- candidly, we're just being a lot more selective in the second half of the -- first half of the year and the second quarter. So we are seeing a lot of opportunity. And multifamily has been our focus right now. It's been 60 -- a little over 60% of closed and signed up deals followed by life science, which has been actually pretty strong for us as well, generally with repeat borrowers and long term relationships. And speaking of repeat borrowers, over 50% of our loans closed to date have been with sponsors that we've transacted with previously. That really helps quite a bit, because it lowers risk and also makes some more efficient execution. These are guys that we know well. We know their capabilities, and have a good familiarity with their track record. That really helps us, and we plan to continue that going forward.

I think, and if I were to add to that. I was just going to say, Tim, if I were to add to that. I mean, I think we're continuing to see spreads that are marginally better than they were pre-pandemic. We're obviously seeing a significantly lower base rate. And we're seeing, because of that, very attractive financing options for ourselves. I mean, I think if you were going to draw the trends out of that, that is where the trends are.

And then as that relates to 3Q activity so far, you guys are off to a pretty good start. But can you maybe just give us some color on the loans that have closed or in the process of closing here? Are they kind of fitting that -- are you staying in the multifamily, life science lane again? How does like the level of transition and kind of spread in LTV compare to what you've been closing through the first half of the year?

Very similar. These -- I think these trends that you're seeing year-to-date are trends that are continuing. We've got -- in addition to those, we've got about $4.5 billion in our pipeline now. And I would say, it's very similar in terms of LTV and spread, and you're not seeing really a change in strategic focus for us. We're focused on high-growth markets with great demographics. Obviously, we're focused on multi and life science. And those strategic thrusts will, I think, characterize the current pipeline as well.

And then just on the dividend, I mean you guys have -- I know that you probably declare the dividend in September for the next quarter, but -- and it's a Board decision, I understand. But you -- a lot of the heavy lifting has been done here. You issued the Series Cs to refinance the Series Bs. So you kind of rightsized the cost of capital there. You did the CRE CLO. You've started deploying a lot more capital than you were before the first quarter. So I'm just curious what, in your opinion, what you need to see further before kind of resetting the dividend to reflect the core earnings power of the platform. And if the Delta variant is something that might kind of prohibit you guys or give you a little bit of pause before doing something like that?

Yes. Obviously, we're always carefully looking at the relationship between distributable and taxable income and our current dividend. And we do make dividend recommendations to the Board. As a general matter, we have taken an approach to our dividend, where we're looking for smooth, steady and sustainable changes to the extent that we make a change. There are a number of factors that feed into that. The macro outlook, as you highlight, I think our capital markets achievements do factor into that as well. Credit performance of the portfolio, which we're encouraged by, and obviously, the earnings power that comes from the originations, which we're also encouraged by. So I think it is premature at this point to say anything. And as you know, we don't give guidance, but we will, of course, be discussing our dividend level with the Board over the coming quarters.

[Operator Instructions]. We'll go next to Rich Shane with JP Morgan.

If we look at the business model historically, I would have described it as ROE -- there's an ROE formula, it's sort of L plus 6.5% to 7.5% with perhaps a 0.5 to 0.6 beta to LIBOR. When we think about the current environment in the construct, do you think that, that framework has changed? Is the spread to LIBOR in terms of ROE lower now, but could we see better correlation as we come off low base rates, particularly if your customers are -- your borrowers are swapping and locking the rates and extending the duration potentially of your loans.

Yes, why don't I start with a general observation, and then I'll turn it over to Bob as well. I think in general, as I said a few moments ago, when you think about the composition of our ROE right now, we are spread heavy and base rate light. And given our leverage model, and the fact that both our assets and our liabilities are floating rate, we do think there's some earnings upside if rates were to rise. But why don't I turn it over to Bob for more specifics.

Thanks Matt. The question is a good one, and it gets to the magic page that we're all familiar with. Matt's right. I think right now, we are in a position where we're still benefiting from high LIBOR floors, and that will persist for a while, at least as long as our vintage loan book is still outstanding. But everyone in the space is transitioning, albeit at different rates from a sort of high floor to a lower floor environment. Spreads have widened a bit to compensate for that. And so, you'll see over the next number of quarters, each company in this space transition. It's -- the components of its ROE will shift. The real question is, will the total ROE increase remain unchanged or decrease. And that will vary, we believe, company-by-company. And frankly, to some extent, it's going to be dependent upon the future direction of interest rates and the real estate markets. The future direction of interest rates seems low for a while, but none of us know. The one thing I would say, Rick, is that the pace of repayments and the behavior of transitional borrowers generally is less yield curve dependent than it is investment and business plan dependent. So that's not to say that borrowers of ours don't hedge. But, generally speaking, they're a lot less focused on rate than they are on their business plans. And so, we don't expect there to be a material change in the volume of floating rate transactions that we have access to over the next number of quarters.

And I think, look, it frankly explains what is a conservative payout ratio as well. Guys, can you hear me? That's it for me.

Any further questions?

That will conclude our question-and-answer session. At this time, I'd like to turn the call back over to Mr. Coleman for any additional or closing remarks.

Thank you, Katie. As you've all have heard on this morning's call, we're pleased with our results and achievements in the first half of the year. Our balance sheet, together with the strength of our team, positions us well for a busy and successful second half of the year. We look forward to speaking with you again next quarter. Thank you.

That concludes today's call. We appreciate your participation.