TPG RE Finance Trust, Inc. (NYSE:TRTX) Q2 2022 Earnings Conference Call August 3, 2022 10:00 AM ET
Company Participants
Deborah Ginsberg – Vice President and Secretary
Matthew Coleman – President
Doug Bouquard – Chief Executive Officer
Robert Foley – Chief Financial Officer
Conference Call Participants
Rick Shane – JPMorgan
Steve DeLaney – JMP Securities
Eric Hagen – BTIG
Don Fandetti – Wells Fargo
Operator
Greetings, and welcome to the TPG RE Finance Trust Second Quarter 2022 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]. As a reminder this conference is being recorded.
I would now turn the conference over to your host, Deborah Ginsberg, Vice President, Secretary. Please go ahead, Ma’am.
Deborah Ginsberg
Good morning, and welcome to TPG Real Estate Finance Trust Conference Call, for the second quarter of 2022. I’m joined today by Doug Bouquard, Chief Executive Officer, Matt Coleman, President, 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 Form 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, its my pleasure to turn the call over to Doug Bouquard, Chief Executive Officer of TPG Real Estate Finance Trust.
Doug Bouquard
Thank you, Deborah. Appreciate it. Good morning, everyone. And thank you for joining the call. As I complete my first quarter as CEO, I first just want to thank the TRTX team and TPG more broadly for welcoming me into the firm. It’s been a pleasure to collaborate with such a talented group of colleagues, and access the depth and breadth of TPG’s global investing platform.
Furthermore, the connectivity among TPG’s integrated real estate group comprised of $18 billion in AUM across debt and equity strategies provides TRTX with a broad perspective across the entire real estate landscape.
First, I’d like to discuss the market over the past quarter. In an attempt to tame inflation, central bank policies have begun to slow economic growth and uncertainty regarding the forward path of the economy has intensified. The effects of tightening liquidity have spread across nearly all asset classes, and frankly, real estate has been no exception.
Within the real estate lending market, we’ve seen a reduction in leverage, a widening of credit spreads, and have begun to observe business plans readjusting with more modest assumptions. Simply put, we find ourselves in a more lender friendly investing environment and TRTX has begun to take advantage of this part of the cycle.
Earlier in the year, we intentionally slowed originations and bolstered our liquidity. And as we head to the second half of the year, this decision has allowed us to do two things. One, deploy capital at more favourable terms and structure, and two, provide ample cushion in the event of further market deterioration and/or negative credit outcomes in our loan portfolio.
While this quarter, the risk rating shift was more muted than the prior quarter, we did materially increase our CECL reserve to reflect deteriorating broader market trends and loan specific credit concerns, particularly within the office sector. This move is consistent with our transparent approach to report it.
For context, we have 12 loans totaling $1.3 billion, with extensions or maturity dates between now and year end. As such, I want to highlight that the expected range of potential outcomes may significantly vary as near term maturities approach, particularly during the second half of 2022.
As the credit markets evolve, and potential credit issues — and potential credit issue loans move toward resolution, we will continue to be steadfast in our risk management approach and laser focused on maximizing value for our shareholders.
Consistent with the conservatism of the prior quarter, we continue to be incredibly focused on our liquidity position and ended the quarter with more than $770 million of total liquidity. That’s broken out $339 million of available cash and $365 million of reinvestment capacity within our existing CRE CLOs.
In addition, we have closed on new note-on-note and term funding facilities that provide term non mark-to-market financing for our lending. And this allows us to diversify away from the CRE CLO market and complement our existing repurchase facilities.
Regarding our existing loan portfolio, during the quarter, we received loan repayments of a total of $757 million, which is comprised primarily of 35% office, 23% multifamily 22% hotel, and the remaining amounts are split between lifestyles and mixed use.
If you look at these metrics by individual quarter, it can skew the picture, especially where any repayment may slip by a week or two take it into a subsequent quarter. And as a function of the market uncertainty, predicting repayment timing will continue to be a challenge for our lenders including TRTX. However, we were pleased to have the ability to redeploy that capital into today’s increasingly attractive lending environment.
To provide one highlight on the range of outcomes with respect to loan resolutions in today’s market, one of the loans repaid in Q2 was a $165 million four rated loan on a convention centre hotel. I highlight this just to reinforce that risk ratings are not necessarily a predictor of losses.
In addition, since quarter end, we received $226 million of full loan repayments, both of which were office loans. On the new origination side, we committed to $380 million of new loans at an average LTV of 65% and a weighted average spread of Term SOFR plus 4.21%.
Consistent with the investment approach, sorry, consistent with the investment focus, we have previously articulated, 87% of the second quarters loan originations were multifamily loans.
Furthermore, since the quarter ended, and during the month of July, we increased our origination velocity meaningfully with another $386 million of loans closed and another $171 million of loans under executed term sheet. And within that population, post quarter end 88% of those loans are also multifamily, with comparable credit metrics to the prior quarters originations.
In terms of our general focus, again, I would say that we remain consistent in favoring multifamily and industrial credits in select markets with institutional borrowers. We have high conviction that these sectors currently present the most attractive risk adjusted returns for our shareholders, while also afforded the most flexibility in terms of financing options. Based on our portfolio as of today, multifamily is now our largest property type exposure at 41% of our loan commitments.
Lastly, with regard to interest rates, I would like to highlight that TRTX’s portfolio is now positively exposed to increases in short term interest rates. For context as of June 30, a 2% increase in short term benchmark rates is expected to result in additional $0.05 per share on a quarterly basis going forward.
While I’ve been in my new role for only three months, I’m very excited about what we’ve been able to accomplish in a short period of time. Our mission is to prudently deploy capital for the benefit of our shareholders boost earnings, and position ourselves to increase the quarterly dividend when appropriate. I believe we’re well-positioned to do so.
In summary, lending conditions have materially improved in TRTX’s favor, we have a strong pipeline of origination transactions. We have over $770 million of liquidity and a debt to equity ratio that is well below our target. And we have a stable financing base with ample capacity to support sustained growth.
With that, I will turn it over to Bob to provide more detail on our results.
Robert Foley
Thank you, Doug, and good morning, everyone. Thanks for joining. Standard quarter every quarter comparisons of income and balance sheet line items and changes in portfolio construction of our loan portfolio and our liability structure are contained in our Form 10 Q and our earnings supplemental. Please refer to them to augment what we discussed on this morning’s call, or for detail on what we don’t discuss this morning.
Three quick data points. First, book value per common share declined quarter-over-quarter by $0.38 per share to $16.03 from $16.41, primarily because the increase in our CECL reserve outpaced the sum of our operating earnings and the $13.3 million gain on sale that we realized on that land parcel on the Las Vegas Strip.
Second, diluted distributable earnings per share covered our dividend per share by a ratio of 1.1 to 1, our year to date payout ratio was 80%. And third, our current quarterly dividend of $0.24 per common share produces an annualized yield of 6% to book value, and 9.2% to yesterday’s closing stock price.
I’ll cover four topics this morning. Components of earnings in particular a bridge from GAAP net loss to common shareholders, on the one hand to distributable earnings on the other. The $42.3 million net increase in our CECL reserve, our capital strategy and our liquidity position.
We reported yesterday for the quarter ended June 30, a GAAP net loss to common shareholders of $8.8 million, and distributable earnings of positive $21.5 million. Here’s a quick bridge and some commentary.
First, net interest margin was virtually unchanged, down only $1.5 million or 1%. Repayments totaled $757 million, although 28.5% of those repayments occurred during the final week of June resulting in an immaterial impact on net interest margin for the quarter.
By quarter end, LIBOR and Term SOFR exceeded our weighted average rate floor at the end of the quarter, which was 90 basis points. Currently, both LIBOR and Term SOFR exceed the highest of our rate floors. As of the mid August interest rate determination date for our loans, the TRTX will be 100% positively levered to rising short term rates.
Second, we recorded a gain on sale of $13.3 million or $0.17 per share from the sale in April of the last 10 acres of land we owned on the Strip. As with our prior gain of $15.8 million recorded in the fourth quarter of 2021, we use capital loss carry forwards to shelter this income and retain 100% of it as equity. Accordingly, this amount is excluded from distributable earnings.
Third, we recorded a net increase in our CECL reserve of $42.3 million to $93.4 million, or 180 basis points as compared to 91 basis points for the preceding quarter. This reserve is unrealized, non-cash and does not reduce distributable earnings.
The increase was comprised of $34.6 million relating to the general CECL reserve, and $7.7 million related to an individually assessed office loan in Houston with a risk rating of five.
The reserve increase was driven by our macro view, which includes a weakening macro economic picture, a substantial increase in short term interest rates since the beginning of the year, high inflation, signs of a possible recession, a recent slowdown in investment sales transactions, and indications that cap rates are on the rise, and risk rating downgrades that reflect our growing concern about operating performance and broader capital availability in the office sector.
Our deal professionals report to us daily about wider loan spreads, reduced loan advanced rates and an imbalance between high demand for capital and reduced investor or lender willingness to provide it. This is a double edged sword positive for those seeking to originate new office loans, but potentially challenging for existing owners and lenders.
On the positive side of the ledger, we received $267.2 million of Office loan repayments in the second quarter, and we’ve received a further $226.2 million since June 30. One note on repayment speeds. Our year to-date repayments if annualized are only slightly faster than our typical historical annual rate. And if our current expectations hold, full year repayments will be in line with our historical speeds.
Unrelated to the earnings bridge, but worthy of note, we paid to our manager an incentive fee of $5.2 million this quarter, because our trailing 12 months core earnings exceeded the ROA hurdle of 7%. The $29.1 million of gains generated from REO sales were a major contributor to this increase.
An optimal capital strategy remains integral to our growth profitability and risk mitigation. We remain laser focused on a low cost of debt capital, longer maturities, limited exposure to mark-to-market risk, excuse me, and financing techniques that support new loan investment activity and our existing loans. At quarter end, our liabilities were 73.7% non mark-to-market within our targeted range.
The CRE CLO markets remain open and functioning. In fact, for the period ending July 31, new issue volume for 2022 was $25 billion, slightly more than the $24.5 billion issued during the same period of 2021.
Nonetheless, we continue to diversify our non mark-to-market term funding sources. Since March 31st, we’ve established a new $200 million non mark-to-market note-on-note facility with a long standing financing relationship, and $108.7 million of non mark-to-market financing with another institutional lender.
During the quarter just ended, we extended the maturities of two credit facilities. Yesterday, we extended a third and we’re in the final stages of extending a fourth. The reinvestment period remains open for two of our three CLOs providing highly accretive non mark-to-market financing for existing and new loan investments.
The weighted average advance rate and credit spread for those two CLOs, which totaled $1.9 billion are 83.6% and 179 basis points respectively. Finally, regarding liquidity, at quarter end, our total liquidity was $771.7 million.
Doug described earlier that we expect the remainder of 2022 to be a target rich market for experienced debt investors via direct origination and loan purchases, since it seems advance rates decline and credit spreads increase week-by-week.
Our measured origination pace during the first seven months of 2022, and our stable capital base leave us favorably positioned to play offense and defense.
With that, we’ll open the floor to questions. Operator.
Question-and-Answer Session
Operator
[Operator Instructions]. We have a first question from the line of Rick Shane with JPMorgan. Please go ahead.
Rick Shane
Thanks, guys for taking my questions. Look, and we’ve asked this on several of your peers calls as well. It definitely feels like there is an ongoing — I will almost use the word rush towards Sun Belt multifamily. I am curious at some point how you guys identify when that space just becomes too crowded, and no longer makes sense. Because from our perspective, we see everybody going there. And we’ve seen the story before and just wondering how this plays out?
Doug Bouquard
Sure. I mean, I’ll say first, I mean, the loans that we have recently funded, generally speaking, are not overly concentrated within the Sun Belt. First of all — and I would say, secondly, we’re starting to see kind of two trends seep into our lending, which is number one, we’re seeing just frankly, a broader array of multifamily across the country driven really more so by the fact that the conduit market is slower as a function of where fixed rate costs are. And then secondly, the SASB market is also slower. So I would say in the in the recent months we’ve seen sort of frankly a broader lens into national multifamily.
Rick Shane
Got it. Okay. And this ties into something we heard yesterday, and it’s more traditional residential credit. But certain markets really starting to show substantial inflation that are seems to be uncorrelated to economic activity or some of the demographic shifts that we’ve seen. Are there markets that you are now particularly concerned about because you’ve seen so much run up in terms of multifamily and would avoid them because of that?
Robert Foley
Good morning, Rick. It’s Bob, and thanks for your question. There are no markets that we would avoid solely because of that. But I think what’s most instructive is to comment briefly on how we think about multifamily more broadly in the context of the housing ecosystem. And how we think about affordability. Housing Affordability is clearly a big issue in this country. And one of the reasons that as a firm on our equity side and the debt side and in TRTX, we’re very active in multifamily is that’s the thesis we believe in. Housing is expensive everywhere. And rising rates are — in our view, driving more people to be renters than even before.
But it has always been the case for us in underwriting multifamily. In particular, that we look really carefully at affordability. We look at share of the wallet that a renter is spending. It can typically range between the low — the high 20s. And in some really tough markets like California, it’s typically, it can range as high as 45% or 50% of monthly household income. So, we’ve always looked at that. So, when we’re looking at a transaction now in a market that may have some of the concerning attributes that you describe, we’re going to catch that up front. That’s going to be one of the first things that our deal professionals look at when they screen a transaction. And that’s clearly going to influence our view about how much runway remains for rent growth. We’re always looking at household formation and job growth and those other things that are fundamental drivers of demand for housing, whether it’s for sale or for rent. So, we understand and appreciate your point. We observe it in some markets. But we wouldn’t cross, necessarily cross any market off the list until we’ve had a chance to do our normal transaction screening, which includes the points I just mentioned.
Rick Shane
Got it. That makes sense. And Doug, I apologize if I cut you off. I have to remember to listen. So I’m not sure if I did, because I think I started talking over you. I do appreciate guys, the transparency and the reserve policy. It’s very helpful and certainly conservative in light of what we’re seeing out there.
Doug Bouquard
Thank you.
Operator
Can we take the next question?
Doug Bouquard
Yes, please.
Operator
Thank you. We have next question from the line of Steve DeLaney with JMP Securities. Please go ahead.
Steve DeLaney
Thanks. Good morning, everyone, and appreciate you taking my questions. You reported some third quarter activity in some credit resolutions, and I just wanted to get some clarity to make sure, two things. I think one of these was a non-accrual loan, a retail property and one was a five [ph] rated loan. And a Bob, am I correct that both of these resolutions are going to close here in the third quarter?
Doug Bouquard
Good morning, Steve. Thanks for your question. Let me address your question in reverse order. With regard to the non-accrual loan, you are correct. We reported that earlier in July, our borrower sold the retail property securing our loan, which was in Southern California. And under an agreement we had with them, we accepted 100% of the net proceeds from that transaction in full satisfaction of our loan. And that amount worked out to be around $18.6 million.
We reserved against that. So we’re actually slightly over reserved versus that final resolution amount. And that difference will flow through in the third quarter along with the transaction in total. So that was previously our only five rated loan. It has been on — was on non-accrual since the end of 2020. The property has been sold. The loan has been extinguished and repaid.
Steve DeLaney
So third quarter will have this $4.4 million or $0.05 impact?
Doug Bouquard
It will, although it will be slightly offset by the fact that it’s slightly over reserved by a little more than a $1 million.
Steve DeLaney
So, for GAAP, you’ll get a reversal I guess on specifics…
Doug Bouquard
A small one, yes.
Steve DeLaney
Okay, great.
Doug Bouquard
Okay. Second — I’m sorry, please continue.
Steve DeLaney
No, no, I was. So what I’m — what it sounds like as we sit here today, that you no longer have any five rated loans or any non-accrual loans. And if that’s not correct, please let me know where everything stands?
Doug Bouquard
Perfect. So with respect to the other loan you raise, which was — it’s the first bullet point in the subsequent events. That’s a new five rated loan Houston office building. That loan is performing. We extended it for a short period right after June 30, which is why it warranted subsequent event disclosure, that loan is performing. And the borrower is in the process of marketing that property for sale. And you can see that we have specifically identified that loan and recorded a CECL reserve separately on that loan. And that reserve amount is disclosed in the footnotes. It’s approximately $11 million. And we disclose how we valued the property in order to determine our reserve amount. And we would expect that that loan would be resolved and repaid I think, before the end of the year and perhaps before the end of the third quarter.
Steve DeLaney
Okay. That’s what I had. And I appreciate the comments, Bob.
Robert Foley
Absolutely. Thanks, Steve. Next question.
Operator
Thank you. So we have next question for the line of Eric Hagen with BTIG. Please go ahead.
Ethan Saghi
Hi, guys. It’s Ethan Saghi on for Eric this morning. Just wondering, is there a minimum level of liquidity you look to keep on the balance sheet going forward?
Doug Bouquard
Good morning, Ethan. Thanks for your question. The answer is yes. That amount varies depending upon a number of factors. We have a model that we use to manage our liquidity generally, and to manage that minimum liquidity amount. The factors that are included in that are, what our covenants require, and we disclose each quarter what minimum cash is required under the financial covenants of our various financing agreements. And all of those covenants are harmonized, so that they have the same minimum cash requirement.
Another important consideration is, forward operating expenses, forward dividend, things of that sort. Another important factor is our expected investment activity, forecasted deferred fundings, under existing loans. Another important risk mitigating factor would be a careful assessment of our borrowings that are subject to credit only marks on repo or mortgage warehouse. And so, we have — this shorthand but sort of a value at risk approach to that. We allocate capital in the event that we elect to remove a loan from a CLO for credit purposes. And so, when you do all of that daily and weekly, which we do, it generates a range of numbers. And I would say on average, that number ranges between about $125 million and $160 million.
Ethan Saghi
Great. Thank you. That’s super helpful. And then my next question would just be, do you see any signs that the CLO market might be stabilizing a bit anytime soon or not?
Robert Foley
Yes, sure. That’s a great question. I would say, first of all, I would say that, the CRE CLO market has remained open, albeit at slightly lower advances and, frankly, wider spreads. I would say right now, generally speaking, we see CRE CLO advances somewhere in the very high 70s. And then sort of like total cost of funds, roughly in the 300 area, that’s obviously moving day-to-day. I think part of what we’ve been monitoring very closely is looking at how CRE CLO spreads, look relative to the investment grade market and the broader CMBS market. And we’re starting to see that, and it’s actually it’s kind of been corroborated by a few research reports on the street, about the fact that CRE CLO spreads appear cheap relative to those other markets.
And then, also if you look at, just even moves in the IG index lately with — the Fed had a slightly more dovish tone which I think really within fixed income markets meant that maybe there is a path forward to the sort of top of the credit curve within IG particularly starting to tighten in. So, if you go back six months, and you really look at the fact that it was really I think, frankly, the IG market, which frankly, led a lot of this wider and frankly, it took the CRE CLO market perhaps a couple of weeks or months to get there. We are starting to see some argument around a little bit of a green shoot as the IG index has frankly come in pretty meaningfully in the last two or three weeks and that should over time bring in the cost of liabilities within the CRE CLO market.
But that being said, we do have other financing channels that that we do pursue. Bob and I both mentioned that we have added both term funding facilities and a notes to our quiver in terms of where we can borrow on our loans. So, again, right now it feels like, despite the CRE CLO market being more expensive, it is open. And we are very focused on sort of watching when that will come to a point where we will be more active borrower there.
Ethan Saghi
Great. Thanks so much. That’s all I got. Thanks, guys.
Robert Foley
Thank you, Ethan.
Operator
Thank you. We have next question from the line of Don Fandetti with Wells Fargo. Please go ahead.
Don Fandetti
Hi. Can you talk a little bit about what you’re seeing on commercial real estate valuations in the different property sectors? And also, what are transitional borrowers sort of thinking today? It seems like it would be difficult to short up, put a new business plan together, just given the uncertainty around the cost of funds?
Doug Bouquard
Sure. I mean, like, obviously, that’s a broad one. And I’ll try and kind of target it. And I would say, look, I think given the fact that as I mentioned, what we closed in Q3, and then also what we have since closed in the first few weeks of — sorry, of what we close in Q2 and what we closed in Q3 thus far. It’s been predominantly multi — so I spend more of my time kind of talking about multifamily, which is — we’ve seen a couple of things. One is, we are starting to see, frankly, private market valuations and where these assets are being acquired at lower price points. I know, we’re really solid in public equities, that move started to really happen, frankly, in later April and early May. And really now in June, July, we’re starting to see transactions reflect that move in public markets. So that’s really one.
And then two. I think that what we’re starting to see also in terms of monitoring both our sponsor underwriting assumptions, and also the lending markets, underwriting assumptions is, we are seeing people underwrite on the debt side, just higher debt yields, simply put, probably, to the tune of an extra 100 basis points. And I would say, in terms of how people are kind of modeling exit cap rates, again, it’s very deal specific and market studies, but I would say, generally speaking, people are underwriting cap rates anywhere from 50 to 100 wider versus what they were doing in Q1.
Don Fandetti
Got it. And then Bob, are you — should we assume that you’ll continue to build reserves in the near term? I mean, obviously, say exactly, but is that kind of the bias here?
Robert Foley
Well, I think that, under the CECL pronouncement, at each quarter end, our reserves should reflect management’s well supported view of what our losses would be on the entire portfolio over the life of those loans. And as you know, we use a loss given default model to help us do that. So, our view today is that reserve reflects what we see today. As we move forward quarter-over-quarter, those amounts could change, they could decline, they could increase, it’s going to be a function of the macro economic environment, the underlying collateral performance of our loans. And to some extent, the composition of our loan portfolio, which was changing fairly quickly in response to our continued focus, as Doug described on affordable multifamily. And the fact that loans and other property types like office and hotel are repaying, and not largely being replaced by loans in those same property categories. But I would say the bias right now, I mean, clearly in other industries, including the banking business is toward higher reserve levels. But we’re — our reserve level at this quarter end is based on our forward look as of today only.
Don Fandetti
Thank you.
Operator
Thank you. Ladies and gentlemen, we have reached the end of the question and answer session, and I’d like to turn the call back over to Doug Bouquard for closing comments. Over to you, sir.
Doug Bouquard
Thank you. Again, I just wanted to thank everyone for joining the call this morning and look forward to reporting back the next quarter. Thank you.
Operator
Thank you. Ladies and gentlemen, this concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.
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