TPG RE Finance Trust, Inc. (TRTX) Earnings Call Transcript & Summary

Hi. Welcome to the 5 PM session of the Citi Conference. I'm Arren Cyganovich. I'm with Citi Research and pleased to have with us Matt Coleman, CEO -- I'm sorry, not CEO, President of TPG Real Estate Fund. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those joining us here today in person to ask management any questions, please step up to one of the mics we have located at the center aisle of the room. If you're joining us remotely, simply type them into the question box on the screen, and they will come directly to us. And we will do our best to ask them during the session. So Matt, I'll turn it over to you, and you can introduce your fine colleague next to you there. And then we'll set it up with Q&A.

Thanks, Arren. I'm joined by Bob Foley, who is our CFO. And as Arren said, I'm Matt Coleman, President of TRTX and I'm the COO of TPG's Global Real Estate platform more broadly.

So we will start off with the question that we're starting every session with. What are the top 3 reasons an investor should buy your stock instead of your listed peers?

Sure. Well, look, I think the first has to be that we are trading, I think, at an unjustifiable discount to book value. And relative to our peers, we've been trading over the last month or so, somewhere between 75% and 80% of book value. And so when you look at the total return that I think is there in the stock, I think that discount is number one. Number two is just kind of a general risk-reward proposition. In what's been an exceedingly low yield environment, maybe that's -- it does feel like that's changing. We still represent a compelling income story together with kind of a natural inflation hedge. And if you can earn high-single digits and at the same time you've kind of got 65-ish-percent LTV exposure to American Real Estate, I think that's a compelling proposition. The third and final reason that I would highlight is that we sit within TPG. And so we're able to avail ourselves of the substantial intellectual capital that's resident within the firm. And we're also able to avail ourselves with the substantial relationships that are resident within the firm. But as well, I'm sure I have more time to talk about over the course of this panel, we're theme-based investors. We're data-driven. We're analytically rigorous investors and having access to the information, the market insights and the people with TPG is a huge strategic advantage for us.

Thanks, Matt. Maybe we could just start off by sharing your CRE lending strategy and how it might differ from some of your commercial mortgage REIT peers?

Sure. Well, as I just alluded to, we are theme-based investors. We have, for the last 18 months or so been focused on multifamily, primarily Sunbelt Multifamily. As a general proposition, we've kind of taken a view that we're trying to put ourselves in the path of secular, not cyclical growth. So we like those markets that are characterized by strong demographics, income, education, job creation, favorable state and local tax regimes, and that's been a theme for us. We have also been investors in life sciences. This is not a new theme for us. We did our first life sciences deal in 2015 shortly after the company was formed. We formed the business in 2014, took it public in 2017. But since then, we've done about $700 million of life sciences deals, and we've done 70% or so of that with a single highly qualified sponsor. That is one of those places where I think we've been able to take advantage of the resources of the firm. We have a very well-connected senior adviser who used to run TPG's Biotech, who advises both us and the TRT side as well as our private equity business. TPG Real Estate as a private equity investor is now one of the 10 largest owners of life sciences in America, having bought 3.7 million square feet over the last couple of years. And that gives us the insight to underwrite complicated conversions to make smart market selection choices and to do the volume of life sciences investing that we've done.

Thanks. How would you describe the lending environment today? And how has it evolved since 2 years ago when the pandemic has began? And are you seeing rational behavior from your CRE lending peers today?

Bob, do you want to take that?

Sure. I'd say, by and large, we are seeing continued rational behavior by our peers. Certainly, we think that we've been -- we've held true to our investing concepts from the beginning. Matt mentioned we're a theme-driven, data-driven. We've historically had a focus on well-capitalized institutional sponsors in the top 25 markets. In those markets, we really haven't seen credit deterioration. We don't see ourselves losing investment opportunities we like to other lenders who have chosen to advance a lot more money against the collateral than we think makes sense or materially loosen credit structures. We have seen some fraying around the edges, but nothing material, nothing at all like what we saw in the mid-2000s before the Global Financial Crisis. So after 2020, which for most private debt platforms and commercial mortgage REITs was a period of either absolute or relative inactivity. 2021 was, a, very busy in terms of both new originations and repayments for us and I think for most of our peers but it was a period of solid investment activity and, I think, very rational excuse me, pricing and credit behavior.

You had mentioned some of the areas that you're focused on investing both type and geography. Are there any areas that you're currently avoiding by type or geography?

Yes. So I mentioned the 2 asset classes where we've been most active. It's probably also worth saying over the last year, we have done a hospitality deal in -- this is a Beverly Hills hotel that we think represented a favorable transaction structure, attractive basis and reasonably attractive pricing for us. We just closed an industrial deal in the Charlotte MSA for a very high-quality sponsor last week. And we've done one traditional office deal here in Fort Lauderdale, where we were, again, putting ourselves in kind of the path of progress, obviously, significant net in migration, particularly from the Northeast. We do, however, generally remain quite cautious on traditional office. I mean, I think sometimes we all have to remind ourselves that we remain in this pandemic. And I think office -- return to office behavior has been choppy, and it's still continuing to manifest itself in ways that we're all learning about. So we're -- we have been and we'll continue to be cautious around traditional office. We're not lending in retail. We have one retail loan in the portfolio, and we're not currently lending in retail. But among the other asset classes that I've mentioned, we are active. We are actively looking at deals, and it's a matter of finding the deals that work for us from a yield and a credit perspective.

So from a spread perspective, where are we today versus where we were pre-pandemic and just curious if there's been much of a change in terms of spreads over the past couple of weeks with all the geopolitical risk that's being added out there these days?

Sure. To your first question, Arren, if you were to compare spreads achieved by us in the fourth quarter of 2019, so the last full quarter before COVID became apparent with the fourth quarter of 2021, the quarter recently ended, spreads were about -- dependent upon the property type in particular, but I would say 20 basis points to 40 basis points tighter in 2019 than they were in the fourth quarter of 2021. One very big difference in terms of overall coupon and yield was that LIBOR floors were considerably higher at the tail end of 2019. Then LIBOR and more recently term SOFR floors are today to give folks a rough basis for comparison. In the last quarter of 2019, floors were typically around 175 basis points. And today, most floors that we're seeing in transactions that we do range between 5 basis points and 20 basis points. So net-net, coupons are largely unchanged or a little bit tighter. They're certainly tighter in multifamily. They're certainly wider in lodging and office. They're tighter at a coupon level in industrial. And as Matt said earlier, retail has never really been involved in the company almost from its inception. And I don't think retail has ever comprised more than 5% of our loan portfolio. And there are a number of fundamental reasons why retail has generally been uninteresting to us independent of rising e-commerce and COVID, frankly.

And I think in some ways, that might have been the beginning and the end of the answer before 10 days ago. I think there's a lot of uncertainty in the world now. We have war in Europe. I don't know that anyone knows exactly how that's going to play out. And I think you're seeing widening in fixed income markets across a variety of asset classes. There's -- we'll see if commercial real estate is immune to that or not. So I think there's no doubt that base rates are going to go up as soon as the 16th, I think. And I think it remains to be seen. I wholly endorse what Bob was saying about spreads. But I think we also have to recognize that the world changed dramatically, and we're all kind of living that in real time.

The one other point of amplification I would make to Matt's comments is that -- in every cycle I've been involved with since the mid-80s. When you see this sort of upset, whether it's war in Central Europe, the collapse of the Russian ruble or the Thai baht, 9/11, the savings and loan crisis, what have you. As credit spreads widen in the capital markets, debt and equity, there is a feedback loop unsurprisingly, but it is sometimes pretty slow in the whole loan commercial real estate market. It takes some time for what's happening in the debt and equity markets to find its way to the way that individual owners and developers and investors price the transactions that they're buying or measure and evaluate the terms of the refinancing that they're trying to get done. And I think we're in the midst of that reset right now. How material it is and how long it takes to get to that reset level remains to be seen. But it has never been overnight the way it can be in CUSIP-denominated markets.

That kind of brings the answer to my next question. There's been a significant amount of private capital being raised, both for properties also for lending. How is that impacting the business? And are you noticing any changes reduced time of whenever spreads widen out, I would imagine it's all that capital available. There's plenty of opportunity for them to deploy that.

Well, there is a lot of capital available. We obviously compete with our public market peers, and we compete with private debt funds. There's been a lot of capital in this space, though, for quite a long time. Transaction volumes are high. And so there are a lot of deals to look at. And it gives us the luxury of not sacrificing credit and financing those deals that we choose to finance. I think this is -- this also ties back to the very first question that you asked which is what makes us different? Why are we distinctive and why are we relatively attractive? And I think this is where being a part of a firm like TPG is really important. We closed an industrial deal 3 weeks ago in the Charlotte MSA for a very high-quality sponsor, repeat borrower, beat personal relationships and a deal that had to close on a highly accelerated timeline. And so there -- we have capabilities. We have the ability to move quickly. We have market conviction and we have deep relationships that help us find those places where pricing and credit appropriately intersect for our business model. But let there be no doubt, it is highly competitive. But I think this is when it's -- this is when our competitive advantages shine.

Got it. You had mentioned short-term rates likely starting to rise off the bottom. It's probably more of a question for Bob. But you've benefited from the fact that your portfolio has a good amount of LIBOR floors. There will be a period of catch-up as rates start to rise off the bottom. But how are you viewing rates overall relative to your portfolio?

Well, it's a great question, Arren. It's something that we and I think everybody in the sector has been focused on for some time now. It's no surprise that rates are rising and will rise further. It sometimes surprise us that people seem relatively unconcerned about it until, I would say, the fourth quarter of last year. We've benefited greatly as have our shareholders from a portfolio of loans that had very high LIBOR floors. And if you've been following the data you've seen that our weighted average LIBOR floors just during 2021 declined from about 1.66% to about 1.10% and continue to decline as 2 things happen. One is our borrowers repay pre-COVID loans with high floors. Last year, our repayments totaled about $1.3 billion, which is actually pretty consistent with what prepayment behavior had been pre-COVID. And the other key factor clearly is the pace of new originations, which, as I described earlier, have much lower rate floors associated with them. So it's a bit of a race. One thing about our industry that I think folks here are familiar with is that repayment and prepayment behavior in our industry is driven more by the pace of the underlying business plan than it necessarily is by the overall rate environment. So we don't expect that repayments will materially slow even as rates rise. Clearly, the margin is going to have an impact. But overall, we don't expect it to be too material. So net-net, the impact on our net interest margin and frankly, most of our competitors, it's sort of a race between the pace at which existing loans repay and the pace at which we put on new loans that have the credit and return attributes that Matt was describing. We think that will become positively geared to rising short-term rates sometime during the second half of the year based on our current expectations about new loan origination business and loan repayments.

So that kind of leads into -- you're talking about repayments. It's been a very active market. I think you grew the portfolio a little under 10%. You're a little under $5 billion now. What's your expectation for growth in this coming year?

I think there's -- we have the potential for a lot of embedded growth. As you said, the portfolio has grown nicely over the last 12 months. We're under-levered, lowly levered relative to our peer set. And as we think about approaching debt to equity levels that are closer to, call it, 3.7x, then it does suggest, again, as Bob was saying, dependent on kind of a normalized level of repayments, but that does suggest kind of the capacity inherent in the business for, call it, asset growth of $1.25 billion to $1.5 billion. So we think that there's -- we're attractive from a growth perspective. We also have -- even now, we have cash liquidity of about $300 million. So there's a potential for, I think, significant growth in the portfolio over the next 12 months and beyond.

And is there an optimal size that you'd like to run the portfolio? It just seems like these your -- peers and others are growing to be pretty large. Is there a certain size level that you'd like to reach or is it not really in your calculus?

I'm not sure that there's a hard and fast rule. I mean, it is true, I think that with size comes some advantages, the ability to spread G&A over a larger portfolio. We get many of the benefits of size sitting within a large real estate and a large private equity business. But I think we're -- growth for growth's sake would not make sense for us and doesn't make sense for many companies. But I think within the parameters that I described earlier, where we see the capacity for growth, again, subject to the right compelling opportunities being there, which we feel good about, I think that kind of growth would make sense for a business like ours. Anything you'd add to that, Bob?

Yes, I mean historically, scale has been very important in credit-oriented businesses like ours. So we'd certainly like to gain more scale, but we're only going to do it in a manner that makes sense from a risk and return standpoint. I think the other bigger macro issue is like, can you be too big? I mean, we're not at all close to relevant range where that becomes an issue. But I think at some point, the question of whether there's enough institutional equity out there to support a truly uber scale publicly traded commercial mortgage REIT is a concept that has not yet been tested, although there are clearly 2, maybe 3, but certainly 2 competitors out there that are probably coming close.

You had some successful credit resolution activities recently. You sold the South parcel of your Las Vegas land portfolio. Can you give an update on your expectations for credit resolutions going forward? By our math, there's roughly 13% risk-rated 4 and 5 loans at the end of last year. What are the conversations with those borrowers? And how do you feel about the underlying assets?

Yes, I'll answer that as specifically as I can because we're talking about a limited subset of assets here, thankfully. But there is only one nonpaying loan in the portfolio, and that's a very small retail deal in Southern California. So we're currently marketing that property for sale, and I would expect over the coming quarters that we'll have something more definitive to say about that process. Based on what we're seeing in the market at this point, I think we feel completely comfortable with where we're carrying that asset relative to reserves and the write-offs that we took at the end of the year. The other piece of REO is the North parcel in Las Vegas, which we elected to market separately than the South parcel, which I think is, I hope, going to turn out to be the right decision. I think it will be. As you mentioned, Arren, we did sell the South parcel late last year to McCarran, the airport in Vegas. They were the natural strategic buyer for it. Needless to say, they are not the natural strategic buyer for the North parcel, which is adjacent to the convention center and across from Resorts World. I think we're generally quite encouraged by activity that we're seeing in Vegas. We're certainly encouraged by what we're seeing on the north end of the strip, which I think there has been a bit of a gravitational move in Vegas development and what we're seeing from South to North. So we feel like we own a really strategic piece of land there. As with the retail asset that I mentioned, we feel good about our carrying value. And I would expect that over the coming quarters, we'll have something more definitive to say. I think more broadly, as you look at our portfolio, everything else is interest paying, as I said. And underlying rent collections are strong, performance is strong. Four, I think, of the 6 loans that we have 4 risk ratings on our lodging assets. And the performance in the lodging portfolio has been strong, as you might imagine. Obviously, that's true for the more resort-oriented properties and the drive-tos, but we're seeing strong performance on a relative basis across the portfolio. And I think if you think about what we all might have thought about lodging, probably for good reason, 2 years ago or 18 months ago, there's a sea change. I mean we're all sitting in a conference room in Miami at a conference that feels like probably for many of us, the last conference that we went to was this one 2 years ago. A lot of people have said that. And so I think that that's -- I think that's indicative on a micro level of what we're seeing in the lodging portfolio and travel is picking up and business travel is picking up. And so all that is to say, when you look at the strength of the portfolio, we're encouraged. We're encouraged not only by the collections that we get, but all the underlying data that we see across the portfolio. And that's a big part of what drives our belief in the book value that I alluded to at the very beginning of our conversation.

Yes. You're somewhat unique that you have some capital loss carryforwards in your pocket now and you're able to use some of that on I guess the north parcel. Are there any other strategies that you're thinking about that where you might be able to utilize some of those carryforward losses?

Sure. There are. We have -- well, stepping back for a moment to put this in context. We started out 2021 with about $203 million of capital loss carryforwards. It was related to the -- those were generated by the losses we sustained on our short-term bond investment portfolio in early 2020. Those carryforwards have no life limitation. So they're effectively perpetual. They can be used only with capital to offset capital gains. Arren mentioned that we had sold the South parcel of the Las Vegas land that we've taken back in late 2020. We had about a $15 million gain there, which was actually more than the valuation reserve that we took against all 27 acres when we took back the property from our borrower at the end of 2020. So we were encouraged by that, and we used these carryforwards to shelter all $15 million of gain so not included in taxable income, not distributed in a straight increase in our book value per share. We would expect to do the same thing with respect to a sale of the North parcel or such a sale to generate a gain. In terms of other strategies, they need to involve a generation of a capital gain. The clearest and most straightforward ways would be for us to own properties, which we could, in the future, sell for a gain. I'm not suggesting right now that there's a strategic sea change a foot at TRTX. But that would be one way. There are some other more corporate-oriented transactions that are available. We've studied many of these things pretty carefully. But I would caution listeners that -- REITs are a creation of the code, and there are also -- there's a particular code Section 382 that governs the use of carryforwards more broadly. And so doing highly structured transactions to -- in order to utilize those is pretty carefully circumscribed by the service. So we think these will be an asset to the company over time. The good news is we have time in which to realize that, but it will take some more work to develop strategies that are appropriate from an investment in a risk and return standpoint, but would also allow us to use those. So in the short run, as we sell assets and they generate capital gains, we'll be able to shield them a 100% without question.

We do have an investor question. What do you attribute the discount to book relative to peers? And what are you and can you do about closing the gap?

It's a good question, and I don't totally know the answer to it. Let me maybe address the question from the other way and talk about what we've done to address the gap, which I think represent a number of achievements. I don't think that there's any one step that's going to totally close the gap. But I do think that there's a mosaic of actions. And so over the course of the last year, we've done several things that I think ultimately are going to contribute to eliminating that gap. First of all, as you all know, we've gone through a CEO transition, and we announced a month or so ago, the hiring of Doug Bouquard from Goldman Sachs, who will be will be the next CEO of TRT, and we're excited about the leadership that Doug is going to bring. Secondly, we -- last summer, issued 6.25% preferred at a $200-ish-million issuance that we used in -- to retire the 11% Starwood preferred that we had taken in the spring of 2020. We had not, as many of our peers did not originated very much during 2020, and we, I think, capably enable demonstrated last year with almost $2 billion of new originations in highly thematic areas. Our ability to grow assets and to do so in a way that reflects the themes and our investing convictions that we've talked about today. We've been active in the capital markets outside of the preferred issuance that I mentioned. We've done 2 CLOs over the last 14 months or so, both highly accretive financings each in excess of $1 billion. And we've had a number of positive credit resolutions, some of which we've had the chance to talk about today with respect to Vegas. So all of those things, we're confident over time is going to close that gap. We expect to continue to have positive credit resolutions. As I said, we're believers in our own book value, and we think that, that gap is going to close. So we're going to keep doing those things that allow us to grow earnings. We -- I should have mentioned, we've increased our dividend 3 quarters ago by 20%. Even with that increase, our distributable earnings have covered our dividend by about 1.2x. So we're going to keep doing that, growing the portfolio, driving earnings, paying a good healthy dividend, resolving the book, the high-performing book that we have. And we expect that the market is going to appreciate that over time.

Thanks. You touched on CLO or issuance that you've done and that's created a nice percentage of non-mark-to-market financing on the liability side. What are you thinking about from a balancing perspective on the funding side -- warehouse versus CLO versus other options?

Well, we have been active -- the deal we did last month was our fifth CLO. So we've issued -- we've been one of the leading diversified lending issuers of CLOs since the market we started in early 2018, we built a pretty good franchise that investors like and respect. So that market has proved to be pretty efficient for us. Pre-COVID, about 50% of our loan portfolio was financed on a non-mark-to-market basis. More recently, that percentage has been as high as 82% or 83% at the end of last quarter, it was 70%. It's a little bit higher now based on the deal we did last month. So I don't think that we'll abandon the CLO market. Spreads have widened in it over the last number of months, but frankly, they've widened everywhere. Our objective has been to run on a secured basis at least about 3-quarters non-mark-to-market, non-recourse and about a quarter other forms of secured financing. I don't think mortgage warehousing or repo will go away. It's very efficient, and it's very quick. And a part of our business is responding quickly with tailored financing solutions to repeat borrowers and quickly can mean 21 days or so. And so having the ability to finance those on a short intermediate basis on some kind of a bank financing arrangement is pretty valuable. I think the next step for us is to -- not to look, we've already looked. But there are some actionable forms of financing that we haven't accessed yet, including the Term Loan B market, potentially secured notes or unsecured notes. We've been a pretty active syndicator of loans, either on a senior mezz or an AB note basis. We've also done some private bilateral CLO-type term financings over the last 4 years or so. So there's kind of a panoply of alternatives available to us out there, and we've tried to use them prudently and in a way that's most accretive to shareholders and also maxes out our risk mitigation. Those are probably the 2 key considerations for us.

It's perfect. Perfect sounding.

There you go.

Thank you. Thank you, Matt and thank you, Bob, for joining us today.

Thanks, Arren.

Thanks, Arren.

And thanks for everybody for coming so late in the afternoon. Time for a drink.

Thank you.