TRTX - NYSE

Good morning, and welcome to the TPG RE Finance Trust First Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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.

Good morning, and welcome to TPG Real Estate Finance Trust conference call for the first 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 our 10-K. We do not undertake any duty to update these statements. 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 today. The broad real estate credit and equity markets continue to face headwinds, driven by elevated interest rates, reduced available liquidity and continued pressure on valuations. Over the past quarter, these trends were exacerbated by the current regional banking crisis, a greater sense of concern over commercial real estate broadly, and the secular pressures facing the office property market. Transaction activity continues to slow across all real estate sectors and is reflected in our relatively modest investment and repayment activity during the past quarter. We continue to be front-footed in acknowledging these market trends and have positioned TRTX accordingly. We've maintained ample liquidity. We've been selective with new investments, and we have continued to proactively asset manage our current balance sheet. Over the past quarter, we originated two loans with total commitments of $124 million, comprised of one portfolio of industrial assets and one hotel asset with a blended LTV of 59%. Each of these loans is financed with matched term, non-recourse non-mark-to-market financing. On the repayment side, we had $228 million of repayments during the quarter, of which 50% of the loan repayments were office loans, bringing our total office exposure down to 27% at quarter-end. Subsequent to quarter-end, we had a $46 million office loan repay, bringing our total office exposure down to 26%, which reflects a 38% decrease in office exposure over the past five quarters. Despite our reduction in net income quarter-over-quarter, our CECL reserve and blended risk ratings remain approximately flat, and we continue to be steadfast in our proactive asset management approach. We work collaboratively with our borrowers in the most effective manner possible, avoiding the "kick the can down the road" approach while acknowledging that "one size does not fit all" when it comes to resolving individual assets. In short, the broad resources of TPG's global investment platform and our deep experience across both the real estate debt and equity business affords us a wide array of asset management tools that TRTX will employ to maximize shareholder value. From a liquidity perspective, we continue to be highly focused on striking the appropriate balance between deploying capital in the new investments on a highly selective basis and maintaining sufficient liquidity for needs as they may arise. Our quarter-end liquidity totaled $663 million, and included $133 million of balance sheet cash and $457 million of CLO reinvestment cash. We intend to continue to maintain ample liquidity to navigate an increasingly volatile market environment. Lastly, our ability to deliver for our shareholders and execute on our business plan is rooted in two key advantages: one, the tremendous insights and perspectives gained through our $20 billion AUM TPG real estate platform; and two, a deeply experienced leadership team with an average of 25-plus years of experience in the real estate credit markets across numerous cycles. With that, I will turn it over to Bob for a review of our financial results.

Thank you, Doug. Good morning, everyone, and thanks for joining us. Regarding operating results, GAAP net income for the fourth quarter was $3.8 million or $0.05 per common share, reflecting a decline of $28.8 million from the prior quarter. The principal drivers of this change were a net change in quarter-over-quarter CECL expense of $18.6 million, largely because the prior quarter included a CECL benefit rather than an expense, and an $8.6 million decline in interest income due largely to an increase during the quarter of $359.7 million in non-accrual loans. Distributable earnings was $13.4 million or $0.17 per common share, down from $23.3 million and $0.30 per share quarter-over-quarter. Dividend coverage did decline from 1.25x to 0.71x, although cumulative distributed earnings for the preceding four quarters covered our dividend at a ratio of 1.17:1. Book value per share declined $0.17 quarter-over-quarter to $14.31 due to an increase in the CECL reserve that was roughly $0.11 per share and a common stock dividend that exceeded distributable earnings by approximately $0.07 per share. Our CECL reserve increased by $7.8 million or 3.6% to $222.4 million. Our CECL reserve rate measured against loan commitments increased to 420 basis points from 395 basis points. We remain entirely focused on creating value for shareholders through the judicious balancing of boosting book value, share price and distributable earnings, our decisions regarding liquidity, speedy resolution of challenged loan investments, liability management and asset allocation followed directly from this overarching goal. Regarding liquidity, we have intentionally maintained high levels of liquidity, roughly 12% of total assets to enable us to seize opportunities that we create or that arise in our loan investment and asset management businesses. At quarter-end, liquidity totaled $662.2 million, including $132.5 million of cash, $457.2 million of CLO reinvestment cash, plus $43.8 million of undrawn capacity under our secured credit agreements. $265.4 million of CLO reinvestment cash relates to FL4. This reinvestment period closed in mid-March 2023. Pursuant to the terms of the indenture, we committed prior to the mid-March closure of that reinvestment window to contribute $265.4 million of existing performing loans to FL4 before the mid-May distribution date. These reinvestments will fully absorb this cash, reduce borrowings under our secured credit facilities by approximately $189.4 million and generate $76 million of net cash proceeds for the REIT's balance sheet. Excluding pro forma earnings from that potential reinvestment of the cash generated from this reinvestment transaction, this activity alone is estimated to generate approximately $0.04 per quarter of net interest margin. Our third CLO remains open for reinvestment through February of next year. We had $192.3 million of reinvestable cash at March 31 in that CLO. This term non-mark-to-market, non-recourse financing with a credit spread of 202 basis points is valuable to us in supporting new loan investments, optimizing our current financing arrangements and sustaining or boosting investment level ROE. Unfunded commitments under existing loans declined by $72.2 million or 17% to $353.9 million, nearly 6.7% of our total loan commitments. Regarding credit, limited liquidity and higher interest rates combined to place increased pressure on the ability of borrowers to repay their loans at maturity via refinancing or sale. Our CECL reserve increased by $7.8 million or 3.6%. This slight increase reflects our clear-eyed assessment of current and expected future conditions in the property and capital markets. And the TRTX was an early mover four quarters ago in identifying looming challenges and adjusting our risk ratings and our CECL reserve accordingly. Last week, we took ownership via deed in lieu of foreclosure of a 375,440 square foot, 73.5% leased office building in downtown Houston. The loan had an unpaid principal balance of $55 million, a 5 risk rating and has an unleveraged cash-on-cash yield to our carrying value of 10%. We are pursuing strategies to optimize property value for shareholders using the expertise of TPG's $20 billion real estate platform and its portfolio companies to augment our asset management team and our very experienced senior management group. Non-accrual loans increased to $550.1 million across six loans from $190.4 million across two loans, which reflects operating challenges faced by several of our borrowers in the office sector and the asset management strategies we have selected for certain of our loans to optimize shareholder value. This increase is a symptom, not a cause, of our earlier increase in CECL reserves and our downgrades in risk ratings. Higher non-accruals caused a reduction of $8.6 million of interest income quarter-over-quarter. Regarding two of our loans, we adopted cost recovery accounting during the quarter, which means that cash interest payments received each month have been and will be applied to reduce the loan balance rather than recognize just current income. Fully 64% of the non-accrual adjustment relates to a loan in Philadelphia secured by a 76% leased office building. We are simultaneously engaged in restructuring discussions with the borrower and the pursuit of our legal remedies, and we'll provide an update next quarter. Our financing of this loan is non-mark-to-market and includes the right at our option to convert our financing to a mortgage, should we eventually acquire the property. This valuable optionality strengthens our ability to generate the best shareholder value from this loan. Our weighted average risk weightings remained unchanged quarter-over-quarter at 3.2 and the dispersion of ratings across our portfolio was largely unchanged. Regarding our loan portfolio, we originated two new loans, involving $123.8 million of commitments, $111.2 million of initial fundings and we utilized only $8 million of balance sheet cash to do so. For the quarter, we received total repayments of $227.8 million, of which $144.4 million were repayments in full. Nearly 50% of these repayments were office loans, including one 4-rated office loan. Quarter-over-quarter, our office exposure declined to 26.5% from 28.5% of our loan portfolio, due primarily to full and partial loan repayments of office loans totaling $113.4 million. And as Doug mentioned, after quarter-end, a $45.9 million office loan repaid. Our emphasis on low-cost non-mark-to-market, non-recourse term funding with maximum available duration remains unwavering. At quarter-end, 74.1% of our secured financing was non-mark-to-market, virtually unchanged from the prior quarter and consistent with our long-standing financing policy. During the quarter, we extended the maturity through May 2024 of a $500 million secured credit facility, and we're in the final throes of documentation of a three-year extension of another existing $200 million secured credit facility. We have three other credit facilities within maturities in the second half of this year, which we intend to extend under existing contractual options to do so. Our leverage remains modest. Total debt to equity was 2.95:1 at quarter-end, virtually unchanged from last quarter's 2.97:1. We remain in compliance with our financial covenants. And with that, we'd be happy to open the floor for questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Stephen Laws with Raymond James. Please go ahead.

Hi, good morning.

Good morning, Stephen.

Hi, good morning, Doug and Bob. First, can we start with the non-accruals? Do you think this number has peaked? How do you think about any additional nonaccruals possibly on some loans you've identified early to watch versus resolution path of the six existing non-accruals? And I guess, I'll start with that.

Yes, sure. And so, on that specific question, I think what's important to highlight, first of all, is our last two quarters, we have seen 4 rated loans pay off at par. So, our general comment on this is that 4s do not necessarily become 5s. We actually had, again, it was Marriott Burbank and then also Colton Corporate Center that were 4s over the last two quarters that did pay off at par. But in terms of our 4s generally speaking, it really kind of ties back into our general strategy, which we've been pretty consistent about over the last few quarters, which is we are focused on maximizing shareholder value. And we acknowledge that there is pressure within the real estate market. However, if we end up with loans that are on non-accrual as we have, if we're heading towards maximizing shareholder value, we still feel comfortable. And I would say, lastly, it's really important to highlight that our quarter-over-quarter risk ratings and also CECL reserves remained relatively unchanged quarter-over-quarter. But no change to how we're approaching it from a risk management perspective. And I think to Bob's point, just to put a really fine point on this, about 64% of that non-accrual is related to one office loan in Philadelphia. And I think it's worth highlighting on that loan that we are currently in discussions with the borrower about a potential modification and we are actively trading proposals. In the interim, we've begun to enforce our remedies and we've applied $5 million of cash flow to reduce our basis in that loan.

Great. Appreciate those comments, Doug.

Thanks.

A second question for me, if you don't mind, Bob. I appreciate the color on the CLO reinvestment opportunities. Still seems like outside of the actions that will take place during Q2 with regards to, I think, FL4. Can you talk about the other $200 million of capacity? If you reinvested that, what type of pickup would we see in net interest income? And then, I guess along the CLO front, any thoughts on FL3, which is amortizing down? And could that be collapsed with those loans being put into FL5?

Sure. Great. Well, let's take those in order. With respect to FL5, as I mentioned, we do have reinvestment cash available there. Doug described earlier that occasionally, well, most frequently, when we recently originated loans, we've funded them directly into one of our two CLOs, now only one CLO that has reinvestment capacity. We can also shift loans from other forms of financing, whether it's repo or note-on-note or A-note or what have you into CLOs. And we do have a reinvestment plan for that cash as well. I chose in my remarks to focus on FL4 because the quantum of cash was higher and the timeframe was nearer. But the mechanics work the same. And in terms of the marginal benefit of reinvesting that cash, it's a function of, frankly, having the interest income from the assets contributed, and then avoiding the interest cost that was used to fund those assets prior to their contribution to the CLO since we're paying the interest cost on the CLOs every month whether we use it or not, so to speak. So that's the math there. With respect to FL3, we monitor that very closely. That deal has been in [indiscernible] since the reinvestment window closed at the end of 2021. We're obviously focused on our potential alternative sources of financing. Although the advance rate is lower and the cost of funds is higher, that is a vintage -- that's a 2019 deal. And even with the deleveraging, the cost of funds is actually not bad.

Yes.

One final point on that, which is, I believe I mentioned this in the prior quarter is we remain very comfortable with liquidity as a function of the fact that we have demand in really a variety of different financing sources, and that's a mix of A-notes, our Series CLO capacity, our secured credit facilities and then other potential private financings that we can arrange. So, from a back leverage and financing perspective, we have a variety of levers, and frankly, over the last three quarters, we've used each of those. But really, in the past quarter -- really in the past two quarters, we've predominantly employed the Series CLOs.

Great. Appreciate the comments this morning. Thank you.

Thank you.

Thanks, Stephen.

Next question comes from Steve DeLaney with JMP Securities. Please go ahead.

Thanks. Good morning, Doug and Bob. Listen, a little surprising given the overall report to see the stock open down so weak, about 10%. Thankfully, it's come back a little. The only thing that I see in the report, and I guess, specifically in the press release was the subsequent event about the Houston foreclosure. So, I'm just curious if you could tell us -- and I know it's subsequent, so it's not in your first quarter data, but can you comment on what -- when you transferred that from a loan to REO in April, I guess, with the carrying value of that office as real estate owned, what that carrying value would be? And do you expect any loss or charges -- charge-offs in the second quarter results related to that subsequent event? Thanks.

Sure. Thanks for the question, Steve. The short answer to that is we'll report on that at the end of the second quarter. We acquired the property last Friday and have been in preparation to do so for some time. And so, we have not yet established what the value as REO will be. The accounting rules for REO are a little bit different than they are for loans. But as you suggest, the math will be the UPB, the CECL reserve will be reversed, and then we will establish a new value that needs to be corroborated by appraisals and market comps and so on. And that will be our carrying value going forward for the duration of our ownership.

Okay. And was this loan number 39 in your disclosures? I guess, Chris sent me this. I guess it was from the 10-Q or from your deck.

Yes, it's on the mortgage schedule. We'll come back during this call to confirm or deny that. Yes, it is. You and Chris were correct in your Sherlock Holmes [indiscernible].

Thank you. Just one quick follow-up, if I may. Interesting to see the hotel lending in first quarter. Can you comment just very generally on the REO profile of those new loan opportunities? How you would compare it sort of to your historical overall expected ROE on the portfolio? And does TPG have specific expertise, experience on the private equity side in the hospitality industry? Thanks very much.

Yes, absolutely. First, just to speak a little bit about the TPG's broader platform, we have about $20 billion of assets under management across both debt and equity. So the short answer is that we do have tremendous experience from both the debt and equity lens within hotels. The loan specifically is an asset in Miami. So, it's a market that we are very excited about. And frankly, it was a transaction that needed to close on a relatively tight timeframe. And we were able to move quickly as a function of the depth and breadth of our team, but also our financing in place that we had on our balance sheet to be able to provide capital with some real certainty to that borrower. Just some other metrics on it for a high level is the asset itself from a leverage perspective is as an as-is LTV of approximately 58%. The interest rate on it was SOFR plus 5.10%. And then, in terms of an expected ROE, it's approximately 12%. So, I think when we look at today's market, the ability to originate a new loan at SOFR plus 5.10% at a 58% LTV is a really attractive allocation of capital.

Great. I would agree. Congratulations on that, and thanks for the comments.

Thank you.

Next question comes from Rick Shane with J.P. Morgan. Please go ahead.

Hey, guys. Thanks for taking my questions this morning. And I don't think this is going to be a surprise given the questions I've been asking throughout earnings for your peers. You're using $75 million a year in cash currently to pay the dividend. Two questions. One, given the taxable income over the last 18 months, what are your dividend -- what is the minimum dividend distribution you would need to make? Do you have any NOLs that you can use to reduce the pay-out? And does it make sense, given particularly where the stock is trading now to reallocate return of capital or balance it a little bit between dividend and repurchase?

Got it. Yes, happy to provide some context there. So, I think from a dividend coverage perspective, I know that Bob mentioned it, but it's worth re-highlighting, which is that over the last year, we did have a 1.17x coverage. And then, the last quarter, we had a 1.25x coverage of the dividend. And I think kind of goes, if you zoom out just a moment, about the fact that from a quarter-over-quarter perspective, we're roughly unchanged on both CECL and on our risk ratings. And we think that, frankly, this near-term volatility in terms of DE is really more a function of our extreme focus on maximizing shareholder value. And I think that's what the most important trend is. And then two, I'll pause there, and then perhaps, Bob, if you want to add?

Yes. Just, Rick, in response to your quasi technical question, like all REITs, we need to distribute really not less than 90% of our taxable income. Once you get below that, you begin to subject yourselves to some excise taxes, which are really inefficient. So, as we made clear, we were undistributed last year. So, from a taxable income standpoint, we do have some spill forward into this year, which will evaluate. You get a year to figure out how to apply all of that. So, distributed earnings is going to move about a little bit over the next several quarters. We've made this clear in our calls the last several quarters as we speedily resolve these loans, in part, to reduce the sub earning assets that Stephen was asking about earlier. So that's our plan, or that's the technical answer in that regard. The second part of your question had to do with net operating losses. We do have a capital loss carry-forwards in the neighborhood of $170 million. We have utilized some of those to effectively shelter gains - capital gains on property transactions that we've had where gains were realized. That's not available under the tax code to shelter ordinary income that lenders like us earn. I hope that directly answers your question.

It does. And then, the second part of that is, in theory, distributing -- distributions in the form of a repurchase or distributions in terms of a form of dividend, shareholders should be, if the stock is trading at par, relatively indifferent, but given where the stock is trading, it starts to become more compelling to repurchase shares. Is there flexibility? Is there interest in doing that?

Well, I think as we've thought about just kind of acknowledging the cycle that we're in, what's happening in the market, we have really put liquidity at the top of our list and think that having that marginal capital on our balance sheet to address any needs as they may arise is really paramount for us.

Thank you, guys.

Thanks, Rick.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Doug, Chief Executive Officer, for any closing remarks.

No, I just wanted to thank everyone for joining this morning, and look forward to keeping you updated on our progress. Thank you.