TPG RE Finance Trust Inc (TRTX) 2017 Q4 法說會逐字稿

Good morning, and welcome to the TPG Real Estate Finance Trust's Fourth Quarter Conference Call. (Operator Instructions) Please note, this event is being recorded. At this time, I would like to turn the conference over to Evelyn Infurna of ICR. Please go ahead.

Good morning, and welcome to TPG Real Estate Finance Trust's Fourth Quarter 2017 Conference Call. On the call today are Greta Guggenheim, Chief Executive Officer; and Bob Foley, Chief Financial and Risk Officer. Greta and Bob will share some comments about the quarter and then open up the call for questions.

Yesterday evening, the company filed its Form 10-K and issued a press release with a supplemental earnings presentation detailing its operating results for the fourth quarter and year ended December 31, 2017, 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 the company's operating results, please see the Risk Factors section of the company's Form 10-K filed on February 26, 2018 with the SEC. The company does not undertake any duty to update forward-looking statements.

During the call, the company will also refer to certain non-GAAP measures. For reconciliations of these non-GAAP measures, please refer to the press release, the Form 10-K and the earning supplemental, all of which are posted on our website and have been filed with the SEC.

With that, it is my pleasure to turn the call over to Greta Guggenheim, Chief Executive Officer of TPG Real Estate Finance Trust.

Thank you, Evelyn. Good morning, and thank you for joining us as we present our results for the fourth quarter and full year 2017. We originated 7 first mortgage loans totaling $495 million in the fourth quarter, and 22 loans totaling approximately $2 billion throughout the year, a 60% increase over the prior year. Year-to-date, we have closed 4 loans totaling $367 million, are in the process of closing 2 more loans totaling $206 million and have a healthy pipeline of potential transactions.

We achieved these strong production levels while maintaining very attractive risk-adjusted returns. Our average spread was 418 basis points for the quarter and 443 basis points for the year. Our lending activity in 2017 and currently has targeted light transitional assets, comprised of pure lease-up and stabilization loans with little or no future fundings. We have not sourced any new construction loans over the last year.

Typically, construction loans would increase one's reported weighted average spread and reduce the weighted average LTVs, while producing, at best, the same return on investment as cash-flowing light transitional loans due to the difficulty in financing construction loans.

At year-end, our portfolio was 98% first mortgages, had a weighted average spread of 476 basis points, an average loan size of $65 million and a weighted average loan-to-value ratio of 59%. At a time when public equity valuations have achieved cyclical highs, we believe the attractive risk-adjusted returns TRTX generates with our high-quality first mortgage loan portfolio provides a compelling reason to invest in our common stock.

An origination focus in 2017, as well as currently, is on multifamily properties. Last year, we originated 10 first mortgage loans totaling $771 million secured by the -- this asset type, or 40% of our total 2017 production volume. In particular, we like affordable, multifamily properties, which are in short supply as new projects have been increasingly focused on luxury Class A apartments that generate sufficient returns to support increasing land and construction costs.

Tenant demand for workforce and affordable housing is very strong and new supply at these price points are at multiyear lows. I should also mention that we like Class A properties in metropolitan areas with strong employment growth, high rates of household formation and where new supply is in sync with demand.

In general, the multifamily properties we have financed, both affordable and Class A, have exhibited high occupancy levels and strong and stable cash flows, which we believe also renders them more resilient in economic downturns. I would also like to comment on a key differentiator for TRTX, which is our well-developed, high-quality asset management team.

We spend a lot of time and energy ensuring that our loan closing process is efficient for our borrowers and that post-closing, our loan servicing and asset management is responsive and user-friendly. We've closed several large loans with borrowers who chose to abandon their existing lenders that were unable to efficiently and timely process loan draws, lease approvals and loan modifications, all of which are key components of transitional lending. We believe our excellence in asset management greatly contributes to our ability to maintain current borrower relationships as well as increase market share by gaining new relationships.

There is much talk about the competitive environment for new loan originations. I suspect there may be questions on this topic so let me address this head-on. The market is highly competitive due to significant capital inflows to new and existing gap funds and other non-bank lenders. Additionally, commercial banks have become more active in originating transitional loans secured by cash-flowing properties.

As we look ahead to 2018, we anticipate tighter credit spreads among all loan types. Importantly, we have succeeded in significantly reducing our cost of funds, including our secured revolving credit facility, as well as our recently closed CLO totaling $932 million, which help offset the impact of compressing loan spreads. Bob will discuss this in more detail.

In this market environment with high property values, strong capital inflows and heated competition among lenders, experience and judgment truly matter. Some borrowers, emboldened by the market liquidity, are seeking borrowing terms that we believe shift significant equity risk to lenders. We know to quickly pass on these transactions.

Fortunately, due to our strong, long-term relationships with borrowers and brokers, we are seeing a lot of national lending opportunities, and focus on those our experience tells us are worthy. We will always prioritize credit. Credit decisions last throughout the life of the loan while market pricing and economics change frequently. Our increased loan origination volumes, attractive loan pricing and strong credit profile clearly demonstrate the quality and strength of our platform.

I will now turn the discussion over to Bob.

Thanks, Greta. Good morning, everyone. As a reminder, details of our operating performance, loan portfolio, capital base and other key performance indicators are contained in our Form 10-K and earnings supplemental, which were filed last evening with the SEC and posted to our website.

First, a quick recap of our fourth quarter performance. In our first full quarter as a public company and our 12th full quarter of operations, TRTX posted GAAP net income and core earnings of $24.8 million or $0.41 per diluted share as compared to $20.8 million or $0.35 per diluted share for the preceding quarter. The quarter-over-quarter increase of $4 million was due primarily to growth in earning assets and increase in LIBOR and a decline in our cost of funds. MG&A expense was in line with forecasts, and we had no material nonrecurring items of income or expense.

We declared in December and paid in January a cash dividend of $0.38 per common share, an increase of $0.05 per share over the prior quarter, which translates into a 7.7% annualized yield on our book value at year-end. The trajectory of our capital deployment and our dividend ramp remains on course. Book value per share at quarter-end and year-end was $19.82, up $0.02 as compared to last quarter.

During the fourth quarter, we originated 7 loans totaling $494.6 million of new commitments, boosting full year originations to almost $2 billion. Net growth in loan assets was $352.4 million or 12.4% over the fourth -- over the prior quarter. Initial fundings under new loan commitments totaled $451.8 million.

The ratio of initial fundings to total new loan commitments for the quarter was 91%, which clearly highlights our focus to originate bridge and transitional loans with limited amounts of deferred funding. This allows us to put more capital to work at the inception of each loan.

Fundings in connection with pre-existing loan commitments totaled $87 million, for a total capital deployment of $539 million. Our estimated asset level return on equity for the fourth quarter was 10%, unchanged from the prior quarter.

The earnings benefit of these new originations will be fully realized in the coming quarters. For our new originations, the weighted average credit spread was 418 basis points as compared to 421 basis points in the third quarter. And for our entire portfolio, the comparable measure is 476 basis points.

Property types included multifamily, office and hotel. Metro areas of note include New York City; Charlotte, North Carolina; and Washington, D.C. Our investment activity remains targeted on large markets with strong employment growth and solid rates of household formation. At year-end, the 10 largest SMSAs accounted for 63% of our loan portfolio and the top 25 SMSAs account for 79%.

Loan repayments totaled $182.7 million, approximately 10% below our long-term average quarterly volume of loan repayments of $209 million. Subject to unforeseen changes in market conditions, we expect a more typical repayment pace in 2018 as compared to 2017 and quarter-to-date results bear that out.

Regarding investment pace and asset growth, I remind you again that we focus on year-over-year patterns, since the timing of loan originations and repayments can and do fluctuate for reasons beyond a lender's control. At year-end, our liquidity and capital position was strong. In addition to cash balances of $75 million, we had available to fund new investments $194.6 million of immediately available undrawn capacity under our secured revolving repurchase facilities, plus $1 billion of available financing capacity under our 5 secured revolving repurchase facilities and 1 senior secured warehouse credit facility, which combined total $2.8 billion of commitments. Plus several note-on-note borrowing arrangements used to finance our dwindling portfolio of construction loans. And finally, a proven ability to create structural, match-term funding by syndicating senior interests in the loans we originate.

Our unfunded loan commitments were $529 million at year-end, of which $109.7 million are associated with construction loans, which will be funded by our asset-specific financings, with the remainder funded from our credit facilities and corporate cash. Assuming asset level leverage of 3 to 1, our estimated potential new investment capacity is approximately $1.1 billion based on no loan repayments, no further CRE CLO issuances and no future note-on-note or nonconsolidated senior interest financings.

Capital deployment and efficiency remains our primary goal in driving sustainable return on equity at the investment level and dividend growth at the corporate level. For the fourth quarter, our asset level leverage, which we define as borrowings divided by the unpaid principal balance of loan investments, rose to 65.1% from 61.9% in the prior quarter.

You may have noticed on Page 14 of the earnings supplemental, we have begun to present a capital utilization rate based on our equity base, which is fully invested, and our substantial financing capacity, use of which has accelerated. Our utilization rate increased to 77.6% at December 31, 2017, as compared to 70.9% at prior quarter end.

During the quarter, we continued to drive down our cost of funds and increased our asset level advance rates to sustain asset level ROEs while delivering cost-competitive first mortgage financing solutions to our institutional borrowers. For loan investments pledged during the fourth quarter, the lender-approved weighted average advance rate was 77% and the weighted average credit spread was 218 basis points, both of which are improved when compared to the previous quarter.

In mid-February, we closed a $932.4 million CRE CLO, which was the second largest of its kind completed since the global financial crisis. In addition to high-quality collateral and a transparent transaction structure, the success of our first broadly held CLO was clearly aided by our lengthy experience as portfolio lenders, asset managers, structured finance issuers and our affiliation with TPG. Investor reception to our transaction was extremely positive. Our pricing was tighter than any comparable transaction. The AAA bonds priced at LIBOR plus 75 basis points, roughly 7 to 10 basis points inside recent transactions. And the transaction was well oversubscribed, with more than 40 separate institutional investors purchasing bonds.

Allow me to quickly recap some key statistics of the CLO. 26 mortgage loan assets were financed with an advance rate of 80% at a weighted average coupon of LIBOR plus 108 basis points, as compared to LIBOR plus 212 basis points for the same mortgage loan assets when financed on our secured revolving repurchase facilities, which generated net financing proceeds of approximately $66.2 million. To put that last number in perspective, that's roughly 1/3 of the net proceeds from our IPO last July.

The economic takeaway, this sharp reduction in our cost of funds and the 7-point increase in advance rate, both in comparison to the same mortgage loan assets financed on our secured revolving repurchase facilities, increased the asset-level ROE to 11% for the 26 mortgage loan assets financed in our CLO. This CLO, and additional CLOs we may execute in the future, provide meaningful benefits to TRTX shareholders. It creates term-matched, index-matched, non-mark-to-market, nonrecourse financing for almost 1/3 of our loan portfolio. The absence of mark-to-market risk alone reduces the amount of defensive cash we must hold, enabling us to deploy capital more efficiently.

It reduces our cost of funds, allowing us to sustain ROE and improve or at least maintain our ability to originate quality loan investments in a highly competitive market. It recycles $670 million of existing capacity within our $2.5 billion portfolio of secured revolving repurchase facilities, enables us to increase velocity and amortize the commitment fees and legal costs of these arrangements, which we've already paid, across more loan investment dollars, and it further diversifies our capital sources. The earnings supplemental contains more detail on this important transaction, and I'm sure we'll receive a question or 2 during Q&A.

Moving quickly to risk management, I'm pleased to report that portfolio risk, as measured by our internal risk-rating system, remained unchanged for the third straight quarter at 2.6 on a scale of 1 to 5, with 1 being of highest quality. We review our entire portfolio several times each quarter and assign fresh risk ratings quarterly. At year-end, we had no loans on nonaccrual status, nor were any impaired. Consequently, we did not record a reserve for loan loss in the quarter, nor have we since inception.

Since last quarter, benchmark interest rates have risen considerably, which is a boon to our business since 99.9% of our loan portfolio and 100% of our funding liabilities are floating rate, indexed to LIBOR. A 100 basis point increase in LIBOR is estimated to generate an additional $0.18 per share of annual net interest income, based on our loan portfolio and our liability structure at year-end.

With that, Greta and I would be happy to entertain your questions. Thanks again. Operator?

(Operator Instructions) The first question this morning will be from Steve Delaney of JMP Securities.

Congratulations on your strong start as a public company. Bob, we had expected to see a CLO transaction at some point. It certainly came faster and larger than we might have assumed, so a good job there. You disclosed in the release that the weighted average coupon was 108 basis points. And apologies if this is in the supplement, because I haven't had a chance to refer to that, but could you comment on the issuance costs and how the issuance costs might increase the all-in effective borrowing rate over the life of the structure?

Sure. Good morning, Steve, and thanks for listening in and your question. The transaction fee -- the all-in cost to us of borrowing on the CLO is measurably inside of what it is on a fully loaded basis for the -- for our repo borrowings. So it's comfortably inside 200 over, which makes this economically accretive even before you think about some of the structural protections that CLOs provide: the no-mark-to-market, nonrecourse and so forth. And we'll be amortizing those costs over the expected life of the transaction, similar to how we and our competitors amortize the costs incurred in putting repo facilities in place.

Why? Did -- that will include the -- I believe you had, what, a 3-year replenishment period on the front end?

Well, the replenishment period is not limited by time. It's really limited by the diversification or the Herfindahl index score of the transaction. So it's really dependent upon the pace at which the initial collateral in the pool repays. So it could be long or it could be short. The weighted average life through BBB-, based on initial expectations, is about 1.6 to 1.65 years, but that's an estimate.

The next question will come from Rick Shane of JPMorgan.

I just want to delve in a little bit more on Slide 14, which is a very interesting slide showing the potential gross investment capacity. First of all, an observation -- and leading into a question. Obviously, you will never run this up to 100% because that would constrain you -- your ability to do the next loan. Where do you think is the optimal investment -- the optimal utilization that you would target before you would consider additional equity capital?

The low 90s, using that measure.

And does this utilization rate contemplate the ability -- you mentioned the 6- or 7-point advantage in terms of using CLOs. What does this assume in terms of CLO issuance going forward?

Well, this is a pretty conservative measure. So it assumes no further CLO issuance, no note-on-note. It really just assumes that we continue to finance all new production using our fairly expansive credit facilities, which is -- we've disclosed -- are on balance advanced at about 66%, 67%. So there would be more investment capacity were we to do another CLO or choose to finance some of our loans by syndicating senior interest in them rather than financing them, either in repo or on a CLO.

Got it. And Bob, the $1.1 billion of funding capacity that you speak about, does that essentially get you to that low 90s utilization rate? I just want to dial everything in.

It would actually get us much higher than that. So we have capacity, we have room.

(Operator Instructions) The next question will come from Arren Cyganovich of Citi.

Touching on the competitive environment. You had mentioned that the banks are starting to get into the transitional loan business. Are you seeing this from a handful of players? Is it more broad-based? And what types of lending are they -- are you starting to see banks more competitive with, in your loan book?

The banks have come back really on assets that have some significant amount of cash flow and some element of transition. Previously, we had not seen them to the extent we are seeing them this quarter and also in the fourth quarter. But these are not assets with major CapEx, it's more lease-up opportunities.

Okay. And in terms of the overall spread environment, can you at all give us an idea of how much spread compression there is on new originations relative to your existing loan spreads on your existing portfolio?

Yes, absolutely. So I think we all talked about last year how spreads compressed. It seemed like mostly in the first quarter. It feels like that's happening again this year. We've seen significant spread compression really since the end of last year and in some cases, it is as much as 50 basis points. But in general, I would say 25 to 50 basis points on transitional loans. And really, it's all loan types. So I would include construction loans, light transitional, heavy transitional, we're seeing the spread compression.

Okay. And the CLO structure will help offset a portion of that, I think you mentioned as well?

Yes. Fortunately, we've been -- we've made great progress in reducing our cost of funds, not only through the CLO but through our credit facility, so I think we've been able to offset it. We would prefer that asset level spreads stabilize. We are hopeful that we've seen the majority of the spread compression this year, but we're not counting on it.

Got it. And then just last question on the use of the CLO versus using the -- your bank facility funding, and understanding that it gives you some more flexibility and potential leverage associated with that, but are there any other structural reasons why you would choose a CLO versus the bank facilities? And does that -- how does that impact your ability to work through, if we head into a recessionary environment and you have some problem assets to work through? Is there a benefit or difficulty whenever you're using a CLO versus bank facilities?

Well, in all cases, whether it's under a credit facility or under the CLO, we retain the control of the asset and the servicing so we have the flexibility to do what we need. If there is a major modification that's required, we would need to refinance the loan under the CLO, because major modifications are not really allowed. But -- so that's why we're very careful when we select which ones we put in a CLO, we think it's the ones that are more likely to perform as planned.

There are -- I mean, yours is a very good question, Arren, and we've obviously thought about the pros and cons of the different financing tools. The clear benefit of the structured finance vehicle, the CLO, is it is nonrecourse, it is match-term. So in the scenario you outlined, where the economy slows down or there are issues, we're not exposed to margin calls or those sorts of things. So we have a stable base on which those assets are financed. And then as Greta mentioned, we do manage those loans under the pooling and servicing agreement, and we have some ability within the context of the CLO structure to work and modify loans, if needed. Not fully unbridled, but reasonable latitude.

But I would like to point out as well that the decision to finance with a CLO or through a repo does not affect our decision to originate a loan. Each loan we originate has to stand on its own from a credit perspective, and how we finance it is a secondary decision.

The next question will come from George Bahamondes of Deutsche Bank.

Just a question on repayments. You had mentioned that -- and I know this is a rough number here -- about $209 million on average of repayments if we're looking at maybe an annualized long-term basis. Is that reflective of the speed that you've seen quarter-to-date in the first quarter this year? Or is it maybe slower in 1Q or maybe elevated? Any color would be helpful.

Sure. Let me take an initial crack at that and then Greta, I'm sure, has some comments on the broader market and its implications for prepayment speeds. Our prepayment experience quarter-to-date is fully in line with that average that we mentioned. That $209 million, $211 million number is a long-term average since inception, and you and others who follow the company know that, that number does vary quarter-to-quarter. We remember very well the second quarter of last year when our prepayments exceeded $800 million. But something in the low- to mid-2s is much more common. And again, we manage our expectations about loan repayments on a specific identification basis. That's one of the other advantages of having a very strong portfolio management business. But again, when you write 3-year loans, you should expect on average about 1/3 of them are going to come back at you every year, and that's probably the best guide of what prepayment activity will be. Greta?

Yes, no, I agree with that. I do think it's -- when you have a tightening spread environment, many borrowers do seek to refi if they can. I think we saw a lot of that happening last year, particularly in the second quarter with our spiked repayments, but we're always prepared for repayments, but fortunately, our origination pipeline is very strong.

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to hand the conference back to Greta Guggenheim for her closing remarks.

Well, thank you all for joining us this morning and for your questions, and very much for your continued interest in TRTX.

Thank you. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.