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

Okay. Good morning, everybody. My name is Gabe Poggi. I'm a sales specialist at BTIG, focused on the mortgage and real estate sectors. I'm pleased to be moderating this panel, if you will, or discussion with TPG Real Estate Finance. Ticker is TRTX. Current market cap of about $800 million, current dividend yield north of 8%. I'm pleased to be joined by Bob Foley, who is the CFO of TRTX. I think we'll start off with Bob giving an overview of the company, and then we'll kind of dive into the landscape.

Thanks, Gabe. Good morning, everyone, and thanks for attending. I feel like I'm in college again because so many folks are seated toward the end of the room, which I will confess is where I sat when I was a college student. But thanks for attending whether here on the webcast. It's great to be together in person. Pretty exciting. It's one of the first times I worn a tie and longer than I can remember. But -- and thanks also to Nareit for arranging this and for Gabe agreeing to serve as the moderator. I'm with TPG, and I'm also the CFO of TRTX. As Gabe said, publicly traded commercial mortgage REIT. We are part of -- we are externally managed by TPG, the $120 billion AUM global alternative asset manager, which as many of you are aware, went public, in its 30th year of operations in January of this year. TRTX went -- was formed in late 2014. We went public in the summer of 2017. We have a very seasoned and experienced team of real estate professionals. Doug Bouquard just joined us as CEO about 5 weeks ago from Goldman Sachs, where he had spent almost 20 years and most recently led or co-led their commercial real estate lending business, which is a pretty substantial business and among other things provided financing to our company and also had led or co-led several of our CLOs. We are a large loan transitional lender. We lend to primarily institutional borrowers around the United States. We are primarily focused on the top 25 markets. Historically, at least 50% of our loan portfolio has been secured by properties in the top 10 MSAs in the country. That percentage has fluctuated over time. It's currently 50%, which is actually a -- what I'd say is a cyclical low, and I can touch on that later when we talk about, or I think we're going to talk about investment themes. We have about $5.6 billion of loan commitments, of which about $5.1 billion are funded. We prefer -- we are familiar with all property types. But for the last several years, we've been focused primarily on multifamily. On life sciences, and industrial, those first 2 property categories are categories where we think we've got a unique comparative advantage. We have the lowest, if not among the lowest cost of debt capital in the commercial mortgage REIT space. We focus on non-mark-to-market liabilities. Typically, 75% to 80% of our liabilities are term and non-mark-to-market. For those of you who own us or have owned this in the past or follow us, you probably know us to be fairly conservative with respect to the advance rates or loan to values on the loans that we make, which typically range around 65% or 66%. And we're also pretty conservative about how we risk rate our loans, which we can talk about, and the CECL loan loss reserve that we put up against our loan book. We think there's a pretty compelling investment thesis behind owning TRTX today. We trade at a 36% discount to book value. We have a dividend yield above 9% on our share price. We have about $350 million of liquidity on the balance sheet. Our leverage ratios are below 3:1. We've got plenty of capital available to deploy. And so that discount to us is not explainable by the credit or any of the other factors that one might think in connection with where a commercial mortgage REIT trades. And so we think it's a pretty compelling investment thesis. And hopefully, today, we can cover some topics that will help you agree with the assertion that I just made. So that's us in a nutshell.

Great. Thank you. And if there are any questions, obviously, just to start shooting or wave a hand or something. So let's talk -- let's go top-down, right? The Fed's raising rates, there's wars in Europe. Everybody is saying, we're heading to a recession, what's kind of the house TPG/TRTX? How do we think about kind of the macro picture? And how is that dictating what you're seeing in the market, not only from an opportunistic perspective but maybe from also a defensive perspective as well? And then we can kind of dig into some sectors in commercial real estate.

Well, it is clearly a period of change in adjustment. Let's talk first about the house view and how that informs how we're investing in credit. So starting at the ultimate house, which is TPG Inc., which again is a $120 billion AUM firm that is active globally and in a number of industries. I would say that the general view is still a good time to invest. Valuations are under pressure globally in all asset categories, and commercial real estate is probably not immune from that. At the real estate level, TRTX is part of a larger real estate platform called TPG Real Estate, has almost $20 billion of AUM. The bulk of that is in a series of opportunistic commercial real estate equity funds and also in a core plus fund, which is about $2 billion, which has a lower return and a lower risk profile. But there are some common themes that inform how we invest in TPG Real Estate on both the equity and the credit side. Clearly, rising rates at some point are going to have an impact on valuation. It's clearly -- certainly over the last couple of months, began to have an impact on the pace of investment volume, although investment volumes are still very high. And for us as lenders, we're driven not only by what's happening in the investment sales market, but also what's happening in the market for refinancings of existing mortgages on commercial properties. Inflation, typically, real estate has been viewed as a commercial real estate, in particular, has been viewed as an effective hedge against inflation. But I also believe that there is considerable concern about housing affordability, which frankly, is a big investment theme for TPG, we'll touch on that. So it's an uncertain market. The fixed income markets have certainly adjusted over the last 3 or 4 quarters. We saw it in the second half of last year and certainly in the first quarter of this year. It's one of the reasons that in the first quarter, we intentionally subdued our lending volumes. We did about $225 million of commercial mortgage direct origination in the first quarter, which is 1/3 roughly of what we would typically do in a quarter. And that was intentional. And it's because we've seen this continuing adjustment in the liability markets globally, but we haven't seen yet the impact on property valuations or even loan spreads or coupons. And in my opinion, I've been doing this almost 40 years, it's been the slowest period of correction that I can recall, but it has finally begun. And I'd say over the last 4 to 8 weeks, we've really seen in the lending market at least that the credit spreads have adjusted, coupons are increasing, and I think people are taking a different and probably a more healthy view of credit. So we actually think today is a much better relative value opportunity for us and lenders like us in the commercial real estate lending markets than [ obtained ] probably certainly over the last quarter or 2 and probably throughout 2021. And so we're pleased with that, and we think we're well positioned, as I mentioned earlier, from a liquidity and a debt capacity standpoint to take advantage of it.

At a high level, has the fact that the CMBS/CRE/CLO machines slowed dramatically and/or stopped, opened up more opportunities or balance sheet lenders to provide capital to folks who are looking for financing?

Yes. The quick answer is yes. We're still in the early stages of that. Transitional lenders like TRTX tend to provide financing to institutional borrowers who intend to effect change to the property that they own or are in the process of acquiring. Generally speaking, those aren't loans that make it into the banking market or into the SASB market, the large single asset securitization market. What we have seen over the last couple of months as the SASB market and the CMBS market have both weakened or at least become less appealing to property owners as borrowers is that some of those loans are starting to migrate into our space. The smallest cost-efficient loan in the SASB market is circa $200 million. The average loan size that we make is -- it is ranged between $80 million and about $120 million over the last 3 or 4 years. On average, the low is probably $30 million and the high is $300 million. So as the SASB deals start to migrate into our world and they are, that's an opportunity for us and one that we fully expect to take advantage of, and we're actually seeing some of those deals right now in our pipeline. So I think that's good. The more conventional CMBS market is less transitional in nature. And therefore, I would expect to see fewer of those deals or a smaller volume of deals of that sort migrating into the transitional lending segment. But in prior corrections, it's been very common for private debt platforms and publicly traded commercial mortgage REITs to capitalize on these sorts of periods of market disruption.

Got it. So you said that the house view is that it's an attractive time to put money to work, opportunities are coming your way. Can we talk about subsectors and where you'd like to put money to work today, what areas maybe a little more defensive and then we can take it one step further and kind of talk about the book as it is today and how you're viewing the current exposure.

Well, I think that our view as a firm at TRTX and frankly, at TPG more broadly is we're a bit, we're very data-driven, very experiential driven and a bit contrarian. And what that means in the context of commercial real estate is if you look at our lending activity within TRTX extending back to our formation in the end of 2014, but realistically, the first quarter of 2015, you'll see that over time, we've moved in and out of different property types. That's true of lodging, which is a very cyclical business. That's true of office, which we'll touch on in a minute. It's true in life sciences. It's true in multifamily. We have never been -- actually, I have never been with this company or any of my prior companies big into retail. That long predates the structural changes that have been setting retail over the last 4, 5, 6 years. But in the basic food groups, we see a couple of pretty clear opportunities, and that's informed our lending over the last several years. One is housing. Housing affordability is a theme across our real estate platform. On the equity side of our business, we are active in single-family for rent. We're active in build-to-rent. We're active in conventional multifamily. These are all as owners. We're also active in things like -- in Europe, things like hospitals and other sort of real short-term housing alternative. So housing affordability is a big theme for us. And we've expressed that in TRTX primarily by being -- or seeking to be a lender of choice for transitional owners of multifamily, generally not new Class A, but properties that have been built over the last, call it, 10 to 25 years in markets with high rates of population growth, household formation, preferably economic drivers that are industries that are in their ascension rather than in their decline, and that has largely led us to be active in the Southeast across the Sunbelt and on the West Coast. So housing, an important theme. Our exposure to multifamily has virtually doubled over the last 3, 3.5 years. Life sciences is another important theme not just for TRTX, but across the firm as a whole. The TPG manages a number of funds in the growth and other sectors. It's probably one of the larger and more successful investors in life sciences, pharma and bio broadly. And we've been shameless about leveraging that intellectual capital in that relationship network to inform how we lend into the life sciences space where we have been active since 2015. So we are not a Johnny-come-lately. It's a complicated business. It clearly has a lot of tailwinds. Public sector valuations or companies in life science have been hit over the last couple of weeks and months as of a lot of technology-driven companies, but that's a sector that we believe in for the long run. And we've been pretty active right now, about 10% of our portfolio is life sciences with a very concentrated group of sponsors who are very well capitalized and have a very long record of experience measured in decades, in particular markets like San Diego and South San Francisco to name 2. So that's an important theme for us. Then you get into the more conventional property types like Office and Industrial. Office, we should probably talk about separately, big secular changes underway. It's the largest segment of our portfolio right now. At quarter end, it was 39% of our portfolio. And Industrial, traditionally has not been an area of opportunity for companies like us because industrial tends not to trade in size that enables one to do a $100 million loan, but that's changing for the reasons that we discussed earlier. And if you look at our originations activity over the last several quarters, you've seen an increasing share of Industrial. So those are our current themes. I think Office is going to be subdued for a while, but at some point, that will become opportunistic again. Lodging, our portfolio of lodging exposure at its peak was probably 24%, 25% in 2015, 2016. It was about 15% going into COVID. It's currently 11% or 12%. But that market is coming back. It's capital starved right now. And so I think opportunistically, there will be some opportunities. And you shouldn't be surprised to see us do at least some lodging lending. We did one hotel transaction in 2021. So that's where we're seeing opportunities on a macro basis that are consistent with our themes, and we have a question.

Yes. [indiscernible] presentation, can you explain the risk ratings that you utilize and how does [indiscernible]?

No. Good question. The question is about risk ratings, how we, what are they and how do we use them? And I think implied in that is how do we assign them? So we rate our loans 1 through 5. Many of our competitors use the same or a similar -- at least they use the same numbers. And in our business, loans sometimes take a [indiscernible] path from origination to repayment. But generally speaking, 3 years average. When we originate a loan, we expect it to be a 3. And so if you look at the distribution of our risk ratings, they're fairly tightly packed around 3.0, and they've ranged between like 2.8 and 3.2 over the last 5 years. So 3 is average according, performing according to business plan as originally underwritten. 2 means it's materially outperforming. You will rarely see a 1 in our portfolio or in my opinion, in any transitional lenders portfolio because the 1 means that they've hit a home run. If that's true, the borrower has likely sold the property or it's refinanced that property into a more conventional life company, CMBS, commercial bank market. So the real categories that matter are 4 and 5. So in reverse order, 5 means that the loan is in default and/or there's the risk of principal loss. We have 1 retail loan. It's been in default since the fourth quarter of 2020. It had an original unpaid principal balance of about $31.2 million. We've recorded about a $10 million reserve against that, and we've actually written off about $8.2 million of that $10 million, and we expect to sell that loan or actually, we expect the borrower to sell the property and retire our loan at a discount in the second half of this year. So we don't underwrite loans out of the gate at a 5. We expect our loans to be a 3 out of the gate. But if credit and performance deteriorates over time, then we'll adjust our ratings accordingly. Many of you noticed or should have noticed, I think, at the end first quarter of this year that we downgraded the risk ratings on 8 of our 21 office loans. We downgraded 1 loan from a 2 to a 3, which means it had been outperforming. And based on our assessment was now average, and we downgraded 7 from 3, which means average [indiscernible], which means they're behind their business plan. And we did that because we, like many others, are uncertain about the path that office will take as it adjusts or recreates itself in a post-COVID economy. And we tend to be pretty conservative about our risk ratings. So I hope that answers your question.

So [indiscernible] 1 loan.

One loan in Southern California in Woodland Hills.

Anything else? All right. Well, we touched on the office at a high-level, right, office and the 7 downgrades. And could you just talk about the office, what loans you have at a high level, right, part of the thought process and just went through it of why moving those 7 down to a 4. They're all still current paying to my knowledge, right, and talk about the sponsorship behind them and maybe give some anecdotes for TRTX's history of being conservative on that 1 to 5 scale, and then also talking about kind of 65-ish LTV there and other assets, Las Vegas comes to mind, where in a scenario where you have to "[ take ] the keys" [indiscernible].

So that's a good and lengthy question, Gabe.

Sorry.

No. That's okay. Hopefully, I'll get partial credit. Well, I think that -- look, office is an uncertain world today. Return to office has been slower than many people expected, slower than I expected. Last week -- excuse me. Last week, the Castle survey of office entry swipes in New York was 38%. That's below the national average of 43%. That's one of the first times that New York has actually fallen below the national average. We don't have a lot of office exposure in New York and that -- which we do have is occupied by tenants like Microsoft and Netflix, I mean, good credits longer term. We do have some multi-tenant exposure in Manhattan. Generally, Class A quality. We have -- one of our largest loans, frankly, is 575 Fifth Avenue, which is publicly disclosed. And the borrowers there -- it's a joint venture between Beacon and MetLife. So I think that's illustrative generally speaking, the kinds of sponsors that we cater to in the office sector. We do have some more entrepreneurial borrowers. We have office exposure in a number of markets, Philadelphia, Atlanta, a limited amount in the Bay Area. We have some in Texas. But we're pretty cautious. You've noticed we haven't originated much in 2021, we did 1/2 office loans. We did an office loan in Fort Lauderdale, which is a growing office market. And then we did a deal in Loveland, Colorado not far from Boulder, which was actually office flex. And I think over time, it's going to end up being life sciences. So office cautious. One of the best mitigants over time again, 40-plus years for a first mortgage lender is don't over advance against the property's value. So if you look at our loan to values across the portfolio as a whole, they range between 65% and 67% since 2015. There are some dispersion, multifamily typically higher, and we've disclosed this information. Each of you probably has your own view about whether property values have declined over the last year. And if so, by how much? But even if you take a look at implied cap rates from where the public specialty REITs are trading, whether it's office or multifamily or what have you, whether property values are down 5%, 10%, 15% from our appraised values in 2019, '18. There's still a considerable amount of borrower equity there or that's our view, at least. And again, our team is very experienced. We've been through a lot of cycles. I'm not saying we're the only team that has been through a lot of cycles, but we have been through a lot of cycles. Modest advance rate and strength of sponsorship along with making the right calls on markets and so on is really the key to success in lending even in challenging market environments.

Very helpful. Let's pivot to rates and the book sensitivity to a Fed pushing on the front end, right, as a floating rate lender. You obviously have liabilities, have some floors in place. Talk about -- you have a nice slide in the deck.

There is some information that we put up on our website in the presentation that we're using in our one-on-ones. And one of the things that we do disclose is what's the distribution, the frequency distribution of our floors by rate. And I will say that people seem to like to invest in companies like TRTX because we're positively levered to rising rates and that's true. Our weighted average floor today is 105 basis points in both LIBOR and Term SOFR are now above that. So on average, we are positively levered, but distributions always matter when looking at averages. We have some high floor loans, loans in particular, that have floors between 175 and 200 basis points, which were originated in the 2017, 2019 vintage. And frankly, we thought, and our originations team worked hard to put in place high floors, floors that were basically at or near LIBOR when those loans were originated. That was a source of above normal earnings for the company for several years. It's now viewed as a millstone I think, around the [ next of us ] and other companies that have some legacy high floor loans in their portfolio. About 62% of our loan book at last quarter end was before COVID, just to give you a sense of what the floor profile looks like. So we are rate sensitive. We expect will become increasingly rate sensitive to the good as loans with high floors repay. We clearly don't control the pace at which those loans repay. But if you think about it, most of those loans are 3-ish years old. Our typical loan product has an initial term of 3 years with 2, 1-year options to extend. And benchmark rates are higher today. Our spreads were wider several years ago. In our experience, borrowers focus on coupon. And so in some instances, some of those loans may stick around. In most instances, borrowers even in a more costly market in which to borrow are looking at how can they refinance their high floor loan with TRTX into something else. So I think you'll see -- as that capital unlocks, I think you'll see our positive gearing to rates improve pretty quickly. And frankly, that's capital that we can then redeploy along with the substantial capital on our balance sheet to continue to drive earnings at the appropriate time, boost the dividend. So the other thing I would add just in terms of rates is it's been several years since rates have risen. But in the lending business, when you underwrite loans, it's one of the fundamentals of Credit 101 is take a look at multiple exits for your loan. Can your borrower get out on a sale? Can they get out on a conventional refinancing? And can they do so not in the current rate and cap rate environment, but can they do so, looking at more normalized credit spreads and benchmark rates over time. And we had always done that, which I will confess in some instances, has made us less competitive on the front end in terms of originations. But in rising market environments like this, it's just another mitigant, I would say, in favor of credit strength as opposed to credit weakness. So that's our view on rates.

I got one more for you with 2 minutes to go. You jump again -- but let's talk about liquidity, right? And kind of the money you can put to work. Obviously, you've talked about areas you [ want ] to work and then how you think that can lead to and you touched on it a bit, but earnings power, dividend power, things of that nature?

So we have substantial liquidity on our balance sheet. We had more than $350 million of cash actually at the end of last quarter. Cash, frankly, goes up and down a little bit based on the pace of repayments versus redeployment and we're able to much better manage the pace at which we deploy than the pace at which borrowers repay us. We've got 3 CLOs outstanding right now, 2 of which are still in their reinvestment period and loans are repaying. So as loans that are financing those CLOs repay, we have financing capacity there. We have a cadre of 6 or 7 mortgage warehouse counterparties that provide and continue to provide 3-year financing to us. We generally run the business at between 70% and 80% non-mark-to-market term funded, and the remainder, we use shorter-term forms of financing, primarily because it's flexible and it's quick. So we have substantial liquidity and debt financing capacity to drive investment volumes. And what we think, as I said earlier, is a pretty good, actually, quite an attractive lending market right now. The other thing we have is, you mentioned earlier, we had one REO property, the only one we've had in our 6-plus years of existence. We sold it in 2 separate transactions. This was some land in Las Vegas on the Strip. And that returned almost $80 million of unlevered capital, which we're in the process of redeploying right now. And that was not earning anything for 12-plus months while we were in the process of marketing for sale of the land. So those are some important drivers of our strategy, which is deploy, use leverage prudently, manage our credit performance, continue to optimize the capital structure. And if we do those things and boost the dividend, then the share price should follow. So that's the investment thesis.

I'd look at Page 16 of the deck, I think it's pretty interesting on the capital deployment scenarios, for [indiscernible].

We tried to do some homework and save people time. But we laid out, they are hypothetical, but if you make a range of assumptions about what kind of ROE we as a lender should be generating on new loans that we originate and we lever the book to approaching 3.75:1. We're currently only about 2.5:1 leverage. It shows what the incremental earnings power of that should be. So clearly, everybody is going to have their own assumptions about many things including ROE, but that's a range of ROEs that frankly, historically, we've generated at the asset level in our business. So any questions because we're down to about a minute according to this blinking red light.

Red light is yelling at us.

Do you have any more questions?

I'm all tapped out.

Okay. Well, then we'll let the class go early. But thank you again for attending. And if you have any follow-up questions, please reach out to me or anyone else at the company, and we appreciate your interest. Thank you.

Thanks.