Good morning, and welcome to the TPG Real Estate Finance Trust Third Quarter 2023 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]. Please note, this event is being recorded. I would now like to turn the conference over to Deborah Ginsberg, General Counsel, Vice President and Secretary. Please go ahead.

Thanks, Stephen. Good morning and thank you for joining us. Welcome to TPG Real Estate Finance Trust conference call for the third quarter of 2023. I'm joined today by Doug Bouquard, Chief Executive Officer; and Bob Foley, Chief Financial Officer. Doug 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 and earnings supplemental 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 results, please see the Risk Factors section of our 10-Q and 10-K. 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 turn the call over to Doug Bouquard, Chief Executive Officer of TPG Real Estate Finance Trust.

Thank you, Deborah. Good morning and thank you for joining our call. Over the past quarter, risk sentiment in the broader market has demonstrably shifted to the negative. The S&P 500 sold off nearly 10%, the 10-year treasury yield hit an all-time high since 2007 of over 5%, and the Fed has remained steadfast in its restrictive policies to slow the economy. Despite the Fed's policy, the labor market has remained resilient, the consumer continues to spend, and the U.S. economy thus far has avoided a recession. Within the commercial real estate market, the move higher in interest rates and weakening risk sentiment has exacerbated many of the same headwinds facing the real estate sector earlier this year. Values are under further pressure, liquidity is constrained, and transaction volumes remain low. Furthermore, the secular challenges within the office space continue to grow as fresh equity and debt capital continues to avoid this property sector. Given the market backdrop, our posture and strategic position remains consistent with prior quarters. We maintain elevated levels of liquidity. We are patient on capital deployment, and we are proactively addressing credit challenge to assets across our balance sheet. Fortunately, it is challenging investment in climates like this where the depth and breadth of TPG's Real Estate Investment platform truly shines. With over $20 billion of AUM across equity and debt strategies, we have valuable insights and perspectives that help drive our investment decisions. Over the past quarter, our decline in net income was driven predominantly by the sale of two office assets, one of which we mentioned last quarter as a subsequent event. As we continued to reduce our exposure to the office market, these two sales reduced our exposure to a borrower experiencing significant operational and liquidity issues and reflected our belief that selling…

Thanks, Doug. Good morning, everyone, and thank you for joining us. Regarding operating results, GAAP net loss to common shareholders was $64.6 million for the third quarter compared to $72.7 million for the second quarter. This largely reflects the sale of two non-performing loans, which generated losses for GAAP purposes of $109.3 million and the conversion to REO of an apartment property in LA, which generated a GAAP loss of $7.3 million. CECL reserves were previously established for all of these loans. Net interest margin for our loan portfolio was $19.5 million versus $26.1 million in the prior quarter, a decrease of $6.6 million or $0.08 per common share, due almost entirely to loan repayments during the third quarter, loan repayments in full I should say, of $261.3 million and in the second quarter of $236 million. Distributable earnings declined quarter-over-quarter to a loss of $103.7 million versus a loss of $14.4 million in the prior quarter due largely to the realized losses from the non-performing loans and REO conversion Doug mentioned. Distributable earnings before realized credit losses was $13.7 million or $0.18 per share as compared to $19.1 million or $0.25 per share in the prior quarter. Non-performing loans declined quarter-over-quarter by a full 42% to $318.1 million. 92% of our loan portfolio, measured by UPB was performing at quarter end. If measured by net loan exposure, which is defined as UPB minus CECL reserves, 95% of our loan portfolio was performing at quarter end. Our CECL reserve decreased quarter-over-quarter by $41.7 million, or 15%, to $236.6 million from $278.3 million last quarter. Our CECL reserve rate declined to 560 basis points from 572 basis points. This decline in dollar terms and basis points reflects our team's progress in efficiently resolving credit challenged loans, recovering capital for investment, and…

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Stephen Laws with Raymond James.

Hi. Good morning.

Good morning.

Doug, I want to start with maybe a bigger picture around the three-rated loans. Kind of, when you think about a little over $3 billion, where do you think you are in identifying kind of things that may face future kind of negative rating migrations versus you're kind of already past what you guys believe is a stress point and you feel really good there. How do you think about that as a risk?

Sure. So, I think, within our three-rated loans, generally speaking, that's where we are -- first of all, have confidence that the borrower is executing on their business plan first and foremost. Secondly, from an LTV perspective, we feel as though we have sufficient cushion in terms of today's values. And then I would say, third, we have a tremendous amount of insight as a function of the sort of broader TPG Real Estate investment platform around where valuation is today. So, we of course have the benefit of those insights as we kind of think through risk ratings, generally speaking.

Great. And then, Bob, I think you mentioned two new five-rated loans. Can you provide a little color on those?

Sure. One is an office building on the West Coast, where the operator has experienced a decline in occupancy, which is not unique to this building. It's fairly market wide in the Bay Area where return to office has been rather slow and underwhelming. And the other is a well leased multi-family property in the west suburbs of Chicago. Both are instances that we've been tracking for a while, and we have asset resolution plans in place for each of those.

Great. And then, lastly, I wanted to touch on earnings and make sure I heard you correct. The repayments of borrowings associated with loans sold would reduce interest expenses around $0.05 and then over the next quarter…

Correct.

The full impact of their CLO replenishment. So, kind of fair to say run rate, distributable earnings are kind of excluding realized losses that will flow through depending on resolutions that we've sort of seen the trough here, given those two dynamics?

Well, never say never, but we do feel like we have fairly good visibility going forward on a number of things. One is that there are several levels -- levers that we have available to pull with respect to setting a new level or equilibrium for recurring earnings for the company. One of them, as you just mentioned, is reducing our non-performing loan balance, where on the one side we're not earning any interest income and on the other side we're paying every month interest expense on funding to maintain that loan position or those loan positions. Doug mentioned earlier, we cut that quarter-over-quarter by 42%. So, and in some instances, those positions are financed very cost effectively. For example, in certain of our CLOs and others, the cost of funds is a little bit higher. So, the savings there can be quite substantial. We have $237.5 million of cash in FL5, as I mentioned, and we estimate that there's an upside node there of around $0.07. We have substantial liquidity on the balance sheet, which as Doug described, by choice, we have elected to date not to deploy, but employing that over the next couple of quarters, if and when we conclude that's the right thing to do. It's really a 10% ROE-ish market today for making appropriate transitional first mortgage loans with strong sponsors. So, there's considerable and meaningful upside there. And I mentioned in my remarks, the company is very low levered in comparison to all really of its public peers. And so, there's an opportunity for upside there too.

Fantastic. Thanks for the color, Bob. I appreciate the comments this morning.

Our next question is from Sarah Barcomb with BTIG.

Hey, good morning, everyone.

Hi, Sarah. How are you?

Hey, good morning. So, you've been removing the more difficult credits from the portfolio via loan sales this year, and you've brought in a couple of new loans with the proceeds, but repayments have been strong as well. So, the portfolio is contracting. Should we continue to assume that part of the dividend will be paid out of book value, given run rate earnings are shaking out a little bit below run rate DE, or how should we think about that?

I'd say, consistent with prior quarters, the decision relating to the dividend is a Board level decision. And that decision, of course, will be a function of our view of the earnings power of the company as we work through credit challenged assets. And then also the available investment opportunities going forward. But, again, that's a Board level decision.

Okay. So, my follow-up is with respect to the five-rated loans, the specific CECL stayed about the same at $175 million, but the total principal balance of that group came down. So, my question is, do the two loans that came into the five-rated pool carry higher loss assumptions than the existing assets? Or did your outlook for those three five-rated loans that were already in there last quarter worsen? How should we think about that dynamic across those five loans?

Hi. Good morning, Sarah. It's Bob. Happy to answer that question. You're correct. There were two loans that moved into five, and so they effectively brought with them the allocated CECL reserve associated with each. There were a small number of loans that were already in the specifically identified pool, where we did slightly increase the reserves, primarily office, and primarily for the reasons that Doug commented on earlier. But relative to the removals, frankly, that resulted from the loan resolutions achieved during the quarter, they were relatively modest.

Thank you.

Thanks, Sarah.

Our next question is from Rick Shane with JPMorgan.

Hey, guys. Thanks for taking my question. I need to queue in before Sarah, because she really hit my primary topic in terms of dividend, but would love to explore this just a little bit more. Obviously, with the realized losses that creates an opportunity to really rethink the dividend. But even if we just start to normalize for recurring spread income, it's unclear whether or not $0.24 is the right run rate. Can you talk about both the dynamic in terms of realized losses and also the ongoing spread income to support the dividend?

Sure. And happy to provide a little more context there. So, just to reiterate some of the important components of that determination, which again is done at a Board level, but we look at current liquidity, our targeted liquidity levels, expectations on credit challenged loans. And then ultimately it comes down to a capital allocation decision. To put some numbers around it. Rick, to your question, net income before credit losses has really ranged between $0.18 to $0.25 per share, and we believe that this is an important precursor to establishing sustaining earnings power once we substantially complete our asset resolution strategy. I think Bob had mentioned within his comments at the beginning of the call that just in deploying the capital within our CRE CLO, which again has substantial amount of available reinvestment, that alone will add approximately $0.07 per share. So, I think, that metric, I think, is important as we really think about, again, establishing the sustainable earnings power of the balance sheet as we've worked through some of the credit challenged assets.

Got it. And, look, I understand the balancing act here, and I appreciate that you guys have been forward leaning in terms of building reserve, transparency, and resolving troubled loans. And I -- we may be in an environment where first loss is best loss, and it's a little bit painful to watch right now. But we look at the disconnect between book value per share, and the -- where the stock is trading, and a dividend policy that allows you, given the losses, probably to retain more capital. Why not be a lot more aggressive on the buyback side at this point than on the dividend side?

Look, I think, we're always looking at ways in terms of optimizing capital allocations. I think that our main focus over the past few quarters, as you know, has been really preserving liquidity. Keeping our liquidity elevated has really allowed us to navigate credit challenged loans, frankly. And I think that's really been at the top of the list. I think, as we work through our credit challenged loans, which, again, we've made a lot of progress, particularly this quarter, and I expect next quarter as well. We will always be thinking about what the appropriate capital allocation is in terms of cash in our balance sheet.

Okay. Thank you very much, guys.

Thanks, Rick.

Thank you, Rick.

Our next question is from Arren Cyganovich with Citi.

Thanks. I wanted to touch on credit migration trends and how they're moving about within the portfolio. Is this still kind of coming from loan maturities that are forcing the sponsors to make a choice, or is there actual kind of deterioration within some of these individual underlying assets?

Good morning, Arren. Thanks for your question. I think that migration is, as we said, it's been pretty stable. We review every loan every quarter. And, look, we've materially reduced office. We've got by choice a significant investment position in multi-family loans. And, as Doug described earlier, the performance there against business plan has been quite good. Clearly, rent growth has slowed, but our entry point there, and frankly, the remaining mark-to-market in a lot of those positions is quite strong. So, we just not -- we feel good about where we're "marked" in terms of risk ratings. Situations change, but that's how we see it right now.

Okay. And then in the fourth quarter, it looks like you have a few maturities, including a couple of fives. Have you had any early indications on how those might play out in the quarter?

Well, yes. We're very proactive in terms of our asset management, and I think the resolutions over the last number of quarters reflect that. So, we do have some loan maturities coming up in the fourth quarter, and we expect that we'll be employing all of the synergies that Doug described earlier. We may see some extensions, we may see some resolutions in the form of sale or REO conversion, and we may see some repayments as well. And we'll be excited and pleased to report on all of that when we speak again in, I guess, it'll be February.

Okay. Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Doug Bouquard for closing remarks.

Thank you. Again, just wanted to thank everyone for taking the time, and we look forward to keeping you update on our progress. Thank you very much.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.