Q2 2023 TPG RE Finance Trust Inc Earnings Call
Good morning, and welcome to the TPG R E Finance Trust's second quarter 2023 earnings Conference call.
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 conference call for second quarter 2023.
I'm joined today by our Chief Executive Officer, and Thoughtfully Chief Financial Officer.
I can probably share some comments about the quarter.
And then well open up the call for questions.
Yesterday evening, we filed our Form 10-Q and issued a press release and earnings supplemental with a presentation of our operating results all of which are available on our website in the Investor Relations.
I'd like to remind everyone that today's call may include forward looking statements, which are uncertain and outside of the company's control actual results may differ materially for a discussion of some of the risks that could affect results. Please see the risk factors section of our 10-Q and 10-K.
We do not undertake any duty to update these statements. 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 it's my pleasure to turn the call over to Doug Burkhardt, Chief Executive Officer.
Thank you Debra.
Morning, and thank you for joining our call.
Over the past quarter the market has begun.
To reflect a greater likelihood of a soft landing at the federal reserve has been successful in dampening inflation without triggering a recession.
Over the past 16 months run and interest rates have increased from zero to their highest level seen in 22 years.
The fed's restrictive policy in place we should acknowledge a few noteworthy takeaways first the labor market remains incredibly strong.
Second the residential housing market has remained resilient positive national price appreciation, despite mortgage rates hovering around 7%.
Third credit spreads in the corporate credit markets have tightened dramatically and I'm almost fully retrace to their pre fed hike levels and.
And lastly, the U S public equity market has rallied nearly 18% year to date.
S&P 500 quickly approaches and all time high.
Despite the broader positive shift in risk sentiment in many asset classes commercial real estate continues to underperform.
And our performance is driven by.
Pressure on values across the true.
The commercial real estate landscape reduce liquidity for debt and equity and secular challenges facing the officemax Ulta.
Ultimately there are a variety of micro and macro economic forces that drive commercial real estate pricing.
But in addition to the headwinds I just mentioned continued uncertainty related to both spot and forward interest rates continued to create volatility on valuations and hesitation on investment activity across the sector.
Our view remains the pressure within the commercial real estate space may persist for an extended period and therefore, we continue to maintain our strategic posture.
First cautiously deploying capital second maintaining a strong liquidity position and third proactively risk managing our investment portfolio in a disciplined and tactical manner, while focusing on long term maximization of shareholder value.
Over the past quarter, our decline in net income to shareholders was driven primarily by a $56 million net increase in our seasonal reserve, which reflects our view of sustained value declines within the office market.
Despite the net increase in our seasonal expense, we continue to make progress reducing exposure to credit challenged assets in may we sold $71 million Brooklyn office alone and post quarter end in July we sold a $129 million office and retail loan located itself.
For each of these loans.
We determined the optimal resolution path was via loan sale and executed accordingly.
It's also worth noting that TRT X provided no seller financing as part of these transactions and on a combined basis the recovery amounts exceeded the carrying value at which we held them on our balance sheet.
For broader context over the past 15 months, we have reduced our cumulative office exposure by approximately $1 billion.
From a balance sheet perspective, we find no new investments. This quarter. However, we did see we did receive $279 million of repayments during the second quarter, primarily from multifamily refinancing activity, while the multifamily sector has experienced cap rate widening over the past year, both debt and equity capital remain avail.
<unk>, albeit at a lower entry point relative to the peak of the QB cycle in 2021.
From a liquidity perspective, we continue to maintain a defensive posture total liquidity exceeded $542 million.
Broken out as <unk> $307 million of cash $206 million of CLO reinvestment capacity and $28 million of Undrawn capacity on our secured credit facilities and our performance. This quarter continues to reflect an asset match and asset management strategy that relies on the depth and breadth of Tpg's broad real estate platform.
With approximately $20 billion, a day, you're going across a mix of debt and equity strategies.
From an asset resolution perspective, we continue to maximize value for our shareholders, regardless of whether we execute a loan modification cell alone or closed on asset. We continue to believe they kicked the can approach for assets facing long term secular headwinds not a winning strategy.
Furthermore, our deep investment experience across multiple business cycles and diverse.
And our diverse real estate investment platform allows us to evaluate and execute on all potential resolution strategies.
Inherent in this approach the market should expect a certain amount of near term volatility in our distributable earnings and this quarter was no different.
However, we continue to have high conviction that this is the optimal long term strategy for our shareholders and will position TRT extra growth as it lost their credit market continues to evolve with that I'll turn it I'll turn the call over to Bob to discuss our financial results.
Thanks, Doug good morning, everyone.
GAAP net loss to common shareholders for the second quarter was $72 7 million.
<unk> GAAP net income to common shareholders of $3 8 million last quarter.
The change was due primarily to an increase in seasonal expense of 81.3 million, reflecting our assessment of further weakening in liquidity for evaluations of office properties nationally.
Net interest margin for our loan portfolio was $26 1 million versus $21 7 million in the prior quarter, an increase of $4 4 million or six cents per common share.
Descript distributable earnings declined quarter over quarter to a loss of $14 million versus earnings of $13 4 million in the prior quarter.
The change was due primarily to realized losses of $33 2 million.
Weighted to two office loans resolved during the second quarter.
One by sale and when by conversion to real estate.
These realized losses approximated the seasonal reserves held against.
Distributable earnings before realized credit losses was $19 1 million or <unk> 25 per share.
A 43% increase from $13 4 million or 17 cents per share in the prior quarter.
Book value per share at quarter end was $13.10 a decline of $1.21 compared to the first quarter of this year due to seasonal expense in the second quarter of $1 15 per share.
Our seasonal reserve increase quarter over quarter by a net amount of $55 9 million.
To $278 3 million from $22 4 million as of March 31.
Our seasonal reserve rate increased to 572 basis points from 420 basis points due almost entirely to further weakening in the office market.
At quarter end, our five individually assessed loans represented 63%.
Of our total seasonal reserve.
Regarding liquidity, we maintain high levels of intermediate excuse me of immediate and near term liquidity roughly 10.9% of total assets to support our loan investment in asset resolution strategies.
Cash and near term liquidity at quarter end was $542 9 million.
Comprised of $307 4 million of cash $206 7 million of CLO reinvestment of cash and $28 7 million of Undrawn capacity under our various secured credit agreements. Our third CLO remains open for reinvestment through February 2020 for.
This term non mark to market nonrecourse financing with a credit spread of 202 basis points as valuable and supporting new loan investments optimizing our current financing arrangements and maintaining a high proportion of non mark to market financing.
During the quarter, we funded $33 million of deferred funding commitments.
Sunday commitments under existing loans declined by $53 4 million to 300, and $300 5 million, which is only six 2% our total loan commitments.
Regarding credit risk ratings remained unchanged at three point too.
Non accrual loans at June 30th totaled $555 6 million or 12, 2% of aggregate U P. B.
Versus $558 9 million or 11, 3% of aggregate U P b for the prior quarter.
The de Minimis net change quarter over quarter masks important asset management activity during the quarter.
We reduced non accrual loans by $126 3 million through the resolution of two office loans during the quarter, one by sale and one by conversion Oreo non.
Non accrual loans increased by $129 2 million related to a five rated first mortgage loan secured by an office and retail property in Manhattan.
That went non accrual during the second quarter due to a maturity default.
That loan was properly sold in July Consequently, nonaccrual loans today totaled $426 4 million.
Nonaccrual status as the logical and often necessary consequence of our asset management steps to resolve loans repatriate capital and thoughtfully allocate it to create shareholder value.
We work to resolve non accrual loans promptly to maximize recovery and boost shareholder value.
We realized losses during the second quarter on two five rated defaulted first mortgage loans both on office properties.
$24 1 million or 303, excuse me or 33, 8% of the loans $71.3 million NPV on a 444000 square foot form of warehouse building converted to office in Brooklyn.
We sold the note after a broad marketing process conducted by a national brokerage firm.
We sustained a $9 million or 16, 2% of the loans $55 7 million U P. B.
On a 375000 square foot office building in downtown Houston.
We converted that nonperforming loan to real estate owned after conducting an extensive loan sale process, which led us to conclude shareholder value will be maximized through ownership skilled property management and leasing using TPG real estate's broad resources and experience and eventual sale.
We borrowed 31.2 million under a five year, 767% fixed rate interest only mortgage loan that is assumable, which we believe may facilitate our eventual sale of the property at the appropriate time.
The building is 77% leased and occupied based on current operating results in mortgage financing our investment generates an 8% return on cost and a 10% Levered ROE after depreciation and amortization expense.
And in late July we sold a $129 $2 million first mortgage loan secured by an office and retail property in Manhattan.
That loan sale is disclosed as a subsequent transaction and will be reflected in our results of operations for the third quarter.
Regarding Cecil our seasonal reserve increased this quarter by $55 $9 million net reflecting a lack of debt capital for office transactions, which has pressured valuations.
Our general reserve declined by $56 $3 million largely due to the transfer of three loans from the general pool to the specifically identified pool are specifically identified reserve increased by $112 $2 million due to increased loan loss estimates and the aforementioned transfers.
Regarding our capital base, our focus remains on maintaining a sturdy diverse financing base, our deep relationships in the financing community and the market power of Tpg's firm wide capital markets business enables us to access and maintain long dated cost efficient debt capital to support our existing portfolio and selective loan purchases.
Originations during.
During the second quarter, we used $265 million of reinvestment capacity Nf L for to finance, an equal amount of six existing loans and retire $189 8 million of borrowings under five different secured financing arrangements quarterly interest expense savings of approximately <unk> <unk> per share.
At quarter end, we had $206 $7 million of reinvestment capacity available in F. L. Five for similar use or to support new loan acquisitions for originations.
We also extended for one year on existing borrowing arrangement with Morgan Stanley with 500 million of committed capacity $54 million of borrowings at quarter end.
We closed a new three year 200 million dollar credit Mark only secured financing arrangement with bank of America.
With $35 9 million of borrowings at June 30th and simultaneously, we allowed to expire a $200 million mortgage warehouse with Bofa that had been in place since 2008.
Yes.
Gil test of our financial Covenant package, which is uniform across all 12 of our secured borrowing arrangements and reduce the threshold to 1.4 times from one five times.
We saw this change to accommodate higher benchmark interest rates.
And elevated levels of nonperforming loans as we continue to execute our asset resolution strategies.
This quarter, we've already delivered notice to exercise our Bayreuth extension of an existing $500 million credit facility with Goldman Sachs with current borrowings of $324 3 million.
At quarter end 71, 7% of our secured financing was nonrecourse non mark to market versus 74, 1% at prior quarter end.
These levels are consistent with our longstanding strategy underlying primarily a non mark to market nonrecourse term funding.
Our debt to equity ratio declined quarter over quarter to 2.79 to one from $2 95 to one.
We were in compliance with all of our financial covenants.
June 30.
And with that we'll open the floor to questions operator.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line isn't the question queue.
You May press star two if would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys. Please hold while we poll for questions.
Okay.
Our first question comes from Stephen Laws with Raymond James. Please go ahead.
Hi, good morning.
Good morning, Steve.
No Bob I guess, you touched on I believe the the sale post quarter end of the five rated mixed use slow on how much of an impact will that have in Q3 and.
How much of that is impacted GAAP versus what's going to run through distributable earnings.
Sure. Good question that transaction is part of third quarter results will be reported in October .
But.
So there will be a loss it will flow through distributable earnings.
The loss were comfortable is.
Covered by the existing system.
Okay. So.
Expect it to be covered but no no material impact to GAAP them.
That's right.
Great touching based on F. L. Five looks like about a little less than 200 million of reinvestment capacity. That's a I guess available through I think December is when that.
That window and can you talk about.
How you look at replenishing.
Lateral there and thoughts about when that might happen and how much net interest income that might add what sun.
Sure.
As Doug.
I'll answer that so okay.
In terms of our liquidity.
Maintained.
This CLO investment capacity really.
Continuously over the past year and really what it allows us to do is have a certain amount of optionality in terms of potential uses of capital.
In terms of how we think about deploying it.
Bob you kind of walk through a more granular detail exactly its effects.
On a per share basis, but.
We expect to be deploying that over the next.
Three to six months generally speaking in advance of that booking window.
No real.
Updated in terms of our process and arc and are choosing our practice is to deploy capital.
And to be specific about the timing F. L. Five has a reinvestment period of two years.
[noise] concludes.
Concludes in February of 2024, there's actually a effectively a 59 day tail on that Youll recall with respect F. L. Four.
Investment period close.
This year.
In March.
We undertook a similar reinvestment strategy, which I described earlier on the call.
That concluded in May.
The rough math there is.
If we were to do the same thing without about five as we did with Apple for and use that capacity to finance existing wells, which is only one of multiple paths stuck just described.
And you assume that our existing loans are borrowed at around 75% under other forms of financing. If we had $207 million of cash and F. L. Five that would equate to about $156 million of repo borrowings, which we would repay.
That cost a little more than 200 over term sofer. So.
That all works out to be a little bit it's basically between four and five cents a quarter of interest savings that would result from F. L. Five reinvestment.
Great. That's helpful. I appreciate the clarification on the on the tail I wasn't aware of that so thanks for that.
Okay.
Thank you. Our next question comes from Rick Shane with J P. Morgan.
Hey, Bob Thanks for taking my questions. This morning, Hey, Doug.
I've been bouncing around so its this is covered in the prepared remarks I apologize.
Can you talk about whether there are any buyouts from the CLO during the second quarter related to defaults and.
Look through the third quarter.
And what's going on in Cielo is anything that you anticipate a bite out.
Sure with respect to the first question Rick No we didn't buy any laws.
Out of any of our CLO in the second quarter.
With respect to what may happen in the future that's really a function of loan performance, which we attempt to predict but no one can predict with.
Perfect precision, it's also a function of the.
The cushion that structured into the Overcollateralization and an interest coverage test of each of our CLO.
For those who have studied our clo's carefully you'll see that for example in F. L. Three which is the most mature of our three outstanding Cielo is we actually have a very substantial overcollateralization.
Our organization buffer there.
So that transaction.
Could actually withstand loan defaults for loans that are in that structure and would remain in that structure.
Without.
Triggering a.
A diversion of cash flow.
Got it and just to be clear and I believe I know the answer to this but I just wanted to make sure when you talked about amending the coverage tests.
That was within that was across your secured credit agreements are correct.
That's correct. So it has no impact on the CLO. So its only with respect to our credit.
<unk> and node on node to the other not CLO financing arrangements.
That's it for me Thank you guys.
Thank you. Thank you.
Thank you. Our next question comes from Sara Bar Com with P. I G.
Hey, everyone on so we're expecting to see some distributable earnings volatility as he spoke to him on that loan sale in Q3 like we saw in Q2, but can you talk about where we sit now with respect to the watch list and should we expect to see additional watchlist migraine.
Shawn and higher specific loss reserve going forward.
Good morning, Sarah.
I appreciate the question. So first of all just address our.
The specific assets at the end.
Generally put them in two categories. The first category as Bob and I previously mentioned relates to the subsequent events disclosure in connection with the sale of.
The opposite retail loan located itself so call that category, one which has been resolved and.
And to Bob's comment, we will be sharing more information on that loan sale at conclusion of our third quarter.
The second bucket, which leaves.
Four five risk rated loans.
Really we are currently pursuing various thresholds various resolution paths, including potential loan sales within that bucket.
And those assets specifically are all office assets across four different office markets.
Philadelphia.
New York, Virginia, and Orange County, and given that we're actively in the market pursuing various paths are mindful of.
Providing transaction specific information at this time, but I think what I, what I would highlight as it relates to arc five rated assets and a resolution of credit challenge loans I think it is worth highlighting that in the in the three loans that that were most recently resolved, including our subsequent event.
We've disclosed.
In the aggregate across those three resolutions they were resolved in excess of our carrying value. So I could see that kind of point point to that in terms of both the comment on our seasonal reserve, but also a comment on our ability to.
Actively resolve credit shelf assets on our balance sheet.
Okay. Thank you.
I mean, you've been managing fan in place issues on your book, but you also originated hotel loan after quarter end. So I was hoping you could speak to how you're thinking about maintaining more defensive liquidity versus going out and originating loans at higher coupons and should we see me where res new originations.
Pick up in the second half of the year or how do you think about that.
Okay. That's a that's a fantastic question and I think as we continue to make progress through our credit challenge loans, you will see us begin to more actively deploy capital in terms of new originations.
I think that you know again as you look at our current bucket of or five risk rated loans as we make progress we look forward to the ability to.
Resolve and then recycle that capital and that's been a pretty consistent strategy of ours.
Bob had mentioned in prior quarters, which is our core view relates to the fact that we don't think that a kick the can strategy for assets that we see having long term secular pressures is going to be a winning strategy for you know for our company. So we've been really disciplined around addressing issues being.
Overly transparent with the market and as we address those issues will be will be very actively engaging in the new origination market.
Just for one moment in terms of capital deployment I think that what we are seeing is actually a.
A very ripe opportunity to be lending I think despite the fact that.
Water risk sentiment.
It's actually very positive across a variety of asset classes as I mentioned in my prepared remarks.
We are still seeing a fair amount of dislocation and opportunity within real estate credit so that really continues to be an underlying.
A key tenant of our investment focus is being able to redeploy capital with some duration in today's wider spread environment at a lower basis. I think there is going to serve that served the company well over the long term.
Thank you.
Thank you.
Thank you. Our next question comes from Steve Delaney with JMP Securities.
Good morning, Doug and Bob.
I enjoy I appreciate your opening remarks, and Doug, especially your macro view well come back to that in a minute.
Bob can you tell us I haven't had a chance to look at the Q, yet, but on the $129 million loan I assume that specific reserve as disclosed in the Q can you share with us what that what that might be the amount.
Ah I cannot we do okay, the scrubbers loan by loan.
Specific reserves.
We do disclose next quarter, you know the law, obviously youll see it flow through the income statement and Doug touched earlier on why we don't disclose our sick well, obviously negotiating with with blown buyers is probably a big thing because you're tipping your hand as far as what you'll take right.
If they know about the reserve.
Well.
[laughter] Alright, dumb question I'll tell I'll move onto the next thing.
Hi.
The one thing that I saw was positive you know to get to be a five you have to probably be a four first the four rated loans dropped for almost 400 million seven loans now at 515, it's 11% of the portfolio.
Versus 18% of the portfolio at March 31.
Overly simplistic I know, but we kind of know what happens with fives, they end up sold or foreclosed or whatever.
But.
If you were to tell any investor you know would there be value for their clients and ourselves as analysts to pay close attention to migration into the four bucket.
As we go through we've obviously as Doug said, probably got another year or longer in this CRE disruption.
But it seems like that's the place if theres one place we can look to get a picture of the future that might be yet just curious how you all think about that.
Hi, Steve Great observation, a couple of comments and I think Doug has somehow.
Some commentary here as well I think youre right.
Our risk ratings are something that we take very seriously they are an important.
Not the only tool, but they are an important tool to help us.
Manage our risk book can also convey to the market.
What are current and future expectations are about loans.
Sure. So for US for is probably the key category, we did have three.
Three loans as we disclosed that migrated from four to five in the second quarter.
We didn't have any inbounds.
And if you look historically.
And history isn't necessarily a guide to future behavior, but if you look at.
Brickley loans that moved into the four category.
A fairly large proportion of them actually don't move to five.
And many of them get resolved.
While being force.
And some actually move back to three but.
It's a really important thing youre right folks should pay careful attention to what we do.
Uh huh.
Yeah look I mean, thank you you are hitting on I think a little bit of a positive in terms of this quarter, which is again, we've been saying now for a few quarters.
We're really focused on being able to be one of the first kind of threw a lot of the challenges again I'll say it again, we can avoid the kick the can we've reduced our office exposure by by over $1 billion in the last 15 months and we and we continue to have a very clear focus on getting <unk>.
Any credit challenges behind us because it just allows us to play offense sooner relative to our to the broader market.
And I would say secondly.
One thing that is worth highlighting in terms of probably the second positive and that does relate to.
If you absent absent our credit losses, what our distributable earnings.
Per share where this past quarter. So I think you know I think I think Bob said, perhaps just re highlight some of those numbers just from a really clear and I think that's probably the.
One of the most important I would say indicators in terms of the potential earnings power of the company and sort of where where we believed to be added I think just worth with pop kind of hitting those numbers one more time, so that sort of all clear collectively on what that looks like.
And so I think the point Doug is directing me too is that.
Distributable earnings before the realized losses for the second quarter were 25 cents, a share which is actually what Eddie.
Here than our dividend.
We were talking Doug commented in his general remarks about the general risk environment and the rate environment and rates are clearly important to us and companies like us, but in terms of our ability to rebuild earnings power.
Rates are actually.
Dairy issues that the biggest issue is clearly for us to move quickly through the credit challenge loans resolve them at the best values possible we had.
At quarter at $555 million.
Nonperforming loans.
All of those are financed so were paying interest on the funding costs.
And we're not collecting interest.
Foregone interest there on an annualized basis by our estimates is 15 16 cents a year in the quarter.
So that could be a potential upside note Steven asked earlier about.
The the math surrounding CLO cash reinvestment.
And then I say the third component is we are intentionally carrying.
High cash levels in order to support.
Our portfolio.
And be able to work toward the the.
The optimal resolutions for each credit challenge loan.
But in a more normalized environment, if we succeed in our objectives, we would not be carrying 300.
40 million Bucks.
There are $310 million Bucks.
Cash and so is that where you can make up your own Ro, but if you assume say a dine in half that's another.
Five or six cents a quarter. So there are clearly some drivers they are all contingent upon.
Executing what Doug articulated and has articulated again and again and that's.
Working thoughtfully, but quickly.
Through our credit challenged loans to achieve the highest recoveries possible for our shareholders.
Well, that's all great color and I appreciate each of your comments. Thank you very much.
Thank you.
Thank you. Our next question comes from Derek Hewett with Bank of America.
Good morning, Doug and Bob I think Bob you addressed my or at least partially addressed my question in terms of the sustainability.
The dividend given youre currently carrying excess liquidity and you have it.
<unk> self help.
Opportunities from refinancing.
Certain loans within the within F. L <unk>, but could you just.
In General just talk about your thoughts in terms of how you determine what the dividend should be set at.
Okay.
Sure Good question Derrick and thanks for dialing in this morning.
You know our view is that that.
Dividend a dividend level for our company and our company in particular ought to be set at a level that matches sustainable earnings power.
There is also a consideration about.
Distributable earnings, which is a pretty close but not a perfect proxy for taxable income and distributing at least 90% of taxable income USA.
REIT rules based.
Driver of dividend levels, as well, but let's focus on the first point.
We just articulated that NIM currently exceeds.
Our dividend level.
Doug described that volatility of distributable earnings is likely to continue as we work to.
Resolve these loans.
Team spends.
Extreme effort.
On that and also in terms of getting our <unk> reserve.
Right, so that we feel that.
The net carrying value of our loans are fairly stated and to Stephen's earlier question in instances, where we do resolve alone that the realized losses closely approximate the Cecil reserve. So all of those are variables in the equation.
And we use that to formulate recommendations to our board because at the end of the day.
The stairs to confirm.
But that's how we think about it.
Okay, great. Thank you.
Thank you.
Yeah.
Thank you there are no further questions at this time I would like to turn the floor back over to Doug <unk> for closing comments.
Thank you just wanted to thank everyone for dialing in this morning, and we look forward to updating you next quarter have a great day.
Yeah.
This concludes today's teleconference. You may disconnect your lines at this time, we thank you for your participation have a great day.
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