TPG RE Finance Trust Inc (TRTX) 2018 Q4 法說會逐字稿

Greetings, and welcome to TPG RE Finance Trust Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Deborah Ginsberg, General Counsel. Thank you. You may begin.

Good morning, and welcome to TPG Real Estate Finance Trust's Fourth Quarter 2018 Conference Call. I'm joined today by 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 we'll open up the call for questions.

Yesterday evening, we filed our Form 10-Q and issued a press release with a presentation of our operating results. All of which are available on our website in the Investor Relations section.

I'd like to remind everyone today 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 discussion of some of the risks that could affect results, please see the Risk Factors section of our most recent 10-K. We do not undertake any duty to update these statements. We will also report certain non-GAAP measures on this call, and for reconciliations, you should refer to the press release and our 10-K.

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, Deborah, and good morning to all who have dialed in. We had a great 2018 at TRTX. Originations and earning assets increased by 30% and 35%, respectively. We've reduced our borrowing spreads by 80 basis points by working with our lenders and issuing 2 CLOs. We increased our funding capacity by approximately $2.3 billion, most notably with $1.5 billion of issuance of the aforementioned CLOs, with a $750 million term loan facility, a $160 million table funding secured facility and by executing in August a $139 million equity raise to fund our significant portfolio growth. Also during the year, we opened a Chicago origination office to support our national origination program and enhance the scalability of our business.

Our strong 2018 originations of $2.5 billion produced a $1 billion increase in earning assets to $4.3 billion, with a portfolio weighted average credit spread of 390 basis points and a weighted average loan-to-value of 64.5%. Despite competitive headwinds, we achieved a weighted average credit spread of 356 basis points on our 2018 originations, while maintaining our focus on first mortgage loans on existing cash flowing assets in major markets. These factors, combined with our increased funding capacity reduced financing cost and increased scale leave us well positioned to drive earnings in 2019 and beyond.

For 2018, core earnings were 99.4% of dividends declared and paid. We target more robust dividend coverage in 2019. We intend to continue to deliver value to our shareholders by increasing book value per share and our dividend yield.

Prepayments remained unchanged in 2018 at approximately $1.2 billion. We believe repayments will moderate in 2019 for 2 reasons: One, all of our construction loans repaid in 2018, which represented 41% of our total repayment; and secondly, we experienced a significant number of repayments by borrowers taking advantage of the continued spread tightening in 2018.

The pace of spread compression appears to have slowed or at least we hope, so we anticipate fewer of these types of early repayments to occur. We can always be surprised to the upside by unexpected asset sales by our sponsors, but it feels like repayments will ease. The composition of our 2018 loans by property type was predominantly office and multifamily, and by loan type, primarily bridge and lease-up transitional loans with modest [feature] funding. Our in-place debt yield at closing was in the mid-6% range, excluding one residential condo inventory loan.

Our average loan size for 2018 originations was $97 million, which we believe is appropriate from a risk management standpoint based on our current equity based of $1.3 billion.

During 2018, we originated no hotel loans and $185 million in hotel loans repaid. At year-end, hotel loans represented only 10% of our loan portfolio. We are currently seeing interesting hotel lending opportunities in certain markets, however.

All of our loan investments are performing and our weighted average loan risk rating remains stable at 2.8 on a scale of 1, the best, to 5, the worst.

We see no credit issues on the horizon. We monitor our loan portfolio vigilantly to anticipate credit issues and to head off borrower refinancing activity by working to retain loans we like at attractive risk-adjusted returns.

We are encouraged by our strong start to 2019. Loans closed or in the process of closing totaled $630 million with a weighted average credit spread of 380 basis points and a weighted average loan-to-value of 66%. The earnings power and attractive risk-adjusted returns of 100% first mortgage loan portfolio is a testament to the strength of our team and the TPG Real Estate Equity Group as well as the overall TPG platform.

Our strong originations start to this year, our growth and earning assets last year of over $1 billion and the significant improvement in our cost of funds and liability structure, position us well to grow earnings in the first quarter and beyond.

Thank you. And I'll now turn it over to Bob.

Thanks, Greta. Good morning, everyone. For the fourth quarter, we generated GAAP net income of $28.6 million or $0.43 per diluted share. That compares to $26.8 million or a $0.42 per diluted share for the preceding quarter. Our quarter-over-quarter earnings growth of 6.7% was driven by net loan growth of $135 million due to the closing of 5 loans with total commitments of $623.7 million and initial fundings of $452.1 million, deferred fundings on existing loans of $50.7 million and repayments of $367.9 million, including the last of our construction loans. And a continued sharp quarter-over-quarter decline in our weighted average credit spread on borrowings against our loan portfolio, which declined 22 basis points or 12% to 165 basis points.

Operating expenses declined 35% quarter-over-quarter, due primarily to continued vigilance and controlling expenses and the initial benefits of a renegotiated loan servicing and loan asset management agreement with our dedicated third-party service provider.

For 2019, we expect our loan servicing and asset management expense line item to be in line with full year 2018, with potential for further reductions in 2020 and beyond.

Book value per share at year-end was $19.76 versus $19.78 at the previous quarter-end, due entirely to a mark-to-market adjustment relating to short-term, fixed-rate, structured finance investments in 2 multifamily loan portfolios issued by Ginnie Mae, whose principal and interest are guaranteed by the U.S. government. Those investments have short weighted average lives of slightly less than 3 years.

We declared in mid-December and paid in January, a cash dividend of $0.43 per common share, unchanged from the prior quarter.

For the full year 2018, our dividends declared and paid equal to almost 100% of our GAAP net income. Our annualized dividend yield is 8.7% on book value per share at December 31, and 8.6% on Monday's closing share price of $20.07.

We intend to announce our initial 2019 dividend per share in March.

For the year, key performance metrics included GAAP income of $106.9 million or $1.70 per share. Core earnings of $107.4 million or $1.70 per share, and total dividends per share declared and paid of $1.71.

Loan repayments for the year totaled $1.2 billion, consistent with our expectations for 2018 and similar to preceding years. Our current expectations, as Greta stated, is for loan repayments in 2019 to decline based on vintage and underlying business plans.

In the fourth quarter, our repayments were front-ended and our originations were heavily back-ended. Many of you assumed a mid-quarter convention for loan originations and repayments. Had our originations adhered to that mid-quarter convention, we estimate our quarterly earnings would have been higher by slightly more than $0.01.

Fourth quarter repayments were spurred by $103.7 million of repayments on residential condominium construction loans. Repayments on construction loans totaled $508 million for the year, reducing to 0, our construction loan exposure at year-end.

Portfolio-wide, loan leverage increased -- loan level leverage increased to 72.8% from 69.6% in the prior quarter, because we reborrowed amounts temporarily repaid in August using proceeds from our equity follow-on and closed in late November, our second CLO of the year and an advanced rate of 79.5%.

We expect this figure to increase further during the first quarter, especially in light of the $629 million of loans we closed or are in the process of closing.

We continue to increase our use of nonrecourse, non-mark-to-market, match-term liabilities to prudently fund our loan portfolio and reduce our borrowing costs. On November 29, we closed our second CRE CLO of the year, increasing to $1.9 billion, our total CRE CLO issuance during the year, making us the top-ranked issuer of CRE CLO liabilities in 2018.

In December, we closed the private nonrecourse, non-mark-to-market secured term loan facility. Our initial borrowing is $114.3 million, secured by one pledged loan. This facility is structured to grow over time to $750 million. In July, we closed a $160 million secured revolving credit facility, to table fund loans. These new financing arrangements established for us during the year, and improved competitiveness and allowed us to sustain our asset level ROEs by reducing our weighted average spread for loan borrowings by 80 basis points.

We reduced financing risk by boosting the proportion of our liabilities funded on a nonrecourse, non-mark-to-market, match-term basis to 52.1% at the end of the year versus 16% at the end of the preceding year. And we enhanced our ability to be flexible, fast, and efficient in delivering constructive financing solutions to our borrowers.

At year-end, our liquidity and capital positions were healthy, with cash balances of $39.7 million, $236.5 million of immediately available undrawn capacity under our various credit arrangements, a high-grade real estate debt securities portfolio convertible into approximately $38 million of cash net of debt, and $2.4 billion of available financing capacity under our financing arrangements. At a targeted leverage of 3.5:1, our estimated capacity for new loan investments is approximately $1 billion, more than ample to fund our current loan pipeline. We continue to require our borrowers to purchase interest rate caps to protect them and us from sharp rises in interest rates that might occur during the term of our loans. And we negotiated LIBOR floors on our loans to protect us against falling rates too.

Finally, we underwrite and monitor our loans with conservative [forward] views of rates and credit spreads and evaluate their impact on future debt service coverage, cap rates, collateral value and eventual repayment of our loans, we are refinancing or sale of our loan collateral.

We continue to emphasize capital preservation through a modest loan-to-value ratio, which has remained consistent by design. It was 64.8% for loans originated during the fourth quarter, 66.7% from loans originated during the year, and 64.5% for the entire portfolio at year-end.

Emphasizing loans secured by properties with shorter business plans and modest amounts of deferred funding. At year-end, 79.4% of our portfolio was comprised of bridge and light-transitional loans, up from 64.2% at prior year-end, and funding 52.1% of our liabilities on a nonrecourse, match-term basis to reduce our exposure to mark-to-market risk on our portfolio.

With that, Greta and I will be happy to entertain your questions. Thanks very much. Operator?

(Operator Instructions) Our first question is from Arren Cyganovich with Citi.

I guess just thinking about the environment overall. How strong do you think your originations could be in 2019 comparative to last year? It sounds like maybe a little bit less competitive than it was maybe starting last year and there was a very strong origination year for the industry, including yourself. But how -- what's your outlook feel like for originations for the year?

Well, based on the start -- our start to the year, we feel pretty encouraged. I would not say that competition has declined. It does still very -- still feel very robust out there. I think the fact that we have added to our team strategically last year and that we are not trying to originate $10 billion a year, that we're able to pick our spots and find the best credit opportunities and the best risk-adjusted returns. I mean, it's -- we are very defensive-oriented. We want to protect capital. My team always gets upset when I try to say a sports analogy, but at the risk of upsetting them, I mean, we are here to win the championship and not to sell tickets, and the championship really is preserving principal value over the long term.

Okay. And the -- on the spread compression, I guess, the deceleration that you mentioned in spread compression. How does that -- what's driving that? And I would think that there would have had to been some deceleration competition to help create that to happen? And do you expect that with all the capital that's still out there on the sidelines that you might see some further spread compression throughout the year?

It doesn't feel like it's going to be at the pace that it was. I mean, the tightest spread we originated last year was one loan at LIBOR plus 270. And you saw that our weighted average spread was LIBOR plus 356. We had not closed another loan tighter than 270 or even at 270 yet, not to say we won't, because I never say never. But it does feel like it has slowed. But there is -- but the competitive pressures are robust. I mean, we are constantly competing with others on -- particularly on the larger loans in the type of markets that we like to lend in. So I can't say that spread compression has gone away, but it certainly feels like it's slowed down dramatically.

Okay. And then just lastly on the leverage. Yes, I think for the industry, spreads were wider a couple of years ago, and it seems like most folks didn't want to go above 3x. Now that you've had some more attractive financing that is non-mark-to-market, et cetera. The leverage targets for a lot of commercial mortgage REITs are starting to creep higher. What gives you the comfort that you can operate at a higher level without adding kind of a new layer of risk to the front?

Well, we will lever the more cash flowing, more stable assets slightly higher than we will assets with more transition. And I think as you see us in a defensive mode gravitate to more and more cash flowing assets, we'll see leverage come up a bit, because those assets types warrant it. For those originators that have a very high percentage of construction loan or subordinate debt, their stated leverage will appear lower. In my mind, it doesn't mean the risk is any different.

Our next question is from Steve Delaney with JMP Securities.

I want to ask a question about your -- the size of your portfolio and sort of your outlook for where that would end up. So the $2.5 billion to queue up to just under $5 billion at the end of the year, and we look across the peer group, the largest senior floating rate portfolio in the group is $15 billion. As you see your overall market opportunity and your specific targeted products, do you have in mind sort of an optimal size of the portfolio that you would like to reach and maintain over the next few years?

Well, I think we, with a $1.3 billion equity base are going to be -- we're going to grow slowly because I think it's inappropriate from a risk perspective for us to try to do $500 million loans and have average loans that are a significant part of our equity. So we -- our growth will be constrained by having -- by focusing on the prudent sized loans for our equity base. But the optimal size, someday, we would love to aspire to give those who are doing $600 million loans a little more competition, but we're not going to be doing that in the near term. And I know that's not really answering your question, but yes, we would --we believe in growth in creating portfolio value and -- but we're going to do growth in an accretive way that builds book value and earnings.

Okay. In that -- you did kind of answer it, Greta, in that you're making $100 million loans now, and what I heard is, you might make an occasional $150 million or even $200 million, but we're not going to see you consistently making $300 million, $500 million loans just to get to $10 billion in a hurry. Is -- did I hear you correctly?

Exactly. Yes, sir.

Okay, fantastic. And the other thing that we're starting to see, and I assume this is really a function of the spread compression that we've been talking about the last 2 years really. But starting to see what I would call a little bit of style drift in terms of the investment menu and where people are allocating capital, can you comment on that? And should we assume looking out over the next year or 2 that it's your plan to stick with your knitting and stick with your senior floating rate strategy?

Yes, we have no plans presently to change our strategy. A few years ago, we have said that we were slowing down on construction loans or -- maybe 2 years ago, but that was in part because of where we were in the cycle and also in part because we had construction loans on our books. Those have all come off. I'm not going to say, we're going to run into the construction loan market because we do feel we are still a bit late cycle and want to be exceedingly cautious on construction loans that would be delivered 3 to 4 years out in an unknown economic environment, and also we'll be cautious on other types of properties that are sensitive to the economic environment such as hotels. But we don't intend to -- we're -- I don't see us really doing -- experiencing any strategy drift.

Bob, I'm sorry -- were you going to say something?

I was just going to add one point, which is so much of the work that the entire team did this last year. On the right-hand side of the balance sheet, in terms of extending the tenure of our liabilities and reducing their cost was to magnify the strategy that Greta articulated, which is, good-sized loans, strong institutional borrowers, short business plans, limited construction, and that kind of financing and the strong capital base that the team has put together. Our ability to win those loans is enhanced with the most competitive cost of capital and the longest tenure liabilities that we can find. So everything we're doing is to encourage a strategy that was to find several years ago and that we have steadily executed since then.

Our next question is from Ben Zucker with BTIG.

The subsequent pipeline looks really good, but I'm wondering if you could provide an expected initial funding balance off of that total? And I'll tell you, I normally wouldn't ask that, but in 4Q '18, it looks like your fundings as a percent of the total commitment value was kind of at the lowest levels since your IPO at around 72% versus a historical average maybe that I calculate around 85%. So I'm just trying to understand, with these subsequent loans, do you think like the funding dynamic is similar to what we saw on 4Q '18 or going back to your historical funding average? That might be helpful.

Great question, and a good diligence, Ben. So you're correct with respect to the observations regarding the percentage of initial fundings to total commitment amounts for the fourth quarter. It was a [twif] lower about 5 points lower than it has been in the proceeding several quarters. That was largely related to a particular loan that we originated for a very strong sponsor on an existing office property where they're basically adding on about 1/3 of the base building office space. They occupied virtually the entire building. So it's a really interesting credit dynamic and a very strong sponsor. But because a significant portion of those proceeds, about 1/3 of it will be used to expand the existing building, our initial funding overall was a little bit lower. But I would characterize that as being exception to the rule. To specifically answer the second part of your question, for the existing pipeline that we disclosed, the percentage of initial fundings to total commitment is in the area of 90%. So 10% deferred, that's a little more consistent, correct, with what you've observed from us the last 4 to 6 quarters, and that's largely a function of Greta's strategy of shortening business plans for the loans that we've -- or for the business strategies that we have financed, and those typically have fewer deferred fundings. The other advantage to that clearly is it allows us to deploy more capital earlier and increase the dollar profits of our loan investments.

That's very helpful, Bob, and that definitely seems like a fundings percentage that we're more accustomed to seeing. And then just following up on that, because I don't want people to hear that and get too carried away with the growth expectations necessarily for the first quarter, is there any kind of callout with repayments that you'd like to make? I know we expect the overall volume to moderate here in 2019 versus 2018, but anything vague or outside that we should be aware of just to help us not get a little too aggressive in our growth here in 1Q?

Yes, sure. The first thing is, we have disclosed this subsequent event in the K. The repayments that we've received thus far this quarter, which were in the neighborhood of $260 million. And barring a surprise, we don't expect any further material repayments in this quarter.

Very helpful. And then if I could -- oh, sorry, sorry. Go ahead, Bob...

No, please continue.

If I could just turn to the operating expense side. Heard your comment about servicing being similar to 2018, it's nice to know that, that arrangement was renegotiated. I'm looking at just professional fees quickly, that $0.5 million looked pretty light in 4Q '18, is that -- should we view that as a go-forward number? Or is that going to normalize back a little bit?

Well, I appreciate your comment about it looking light. We always tried to -- the entire team here is always very focused on getting good value for our professional service expenditures in MG&A generally. I think that the team has done a great job of managing expenses. I think the fourth quarter -- I think the run rate might be slightly higher than that, but not materially higher. So I think that's a decent number. I think you should focus -- if you look into 2018 numbers in comparison with '19 and beyond, I think you should focus on the year as a whole, as a pretty good guide to where we're heading. And the only possible exception to that would be servicing in asset management. And I think, we provided extremely clear guidance on where we see that number going. And that is a really -- that is a -- just one last thing if I may, that servicing and asset management platform is essential to the effectiveness of our business, you've heard Greta go on about this time and time again, but in terms of borrower service, risk mitigation, generating new business and providing a valuable feedback loop as we underwrite new loans, controlling that effectively in-house, although, we use a third-party provider who works only for us, is a really -- is a real competitive advantage for us.

Our next question is from Rick Shane with JPMorgan.

Just sort of finalize the point you were just making, you made the comment that in 2020 and beyond, you expected that, that servicing fee could go down, is that a renegotiation of the existing contract or what drives that?

Well, I think two things. It's good question. One is, it's the arrangement that we've struck with our counterparty. The other is that we continue to inject technology for lack of a better term into that whole business and there are significant productivity gains to be achieved from that. And as a consequence, we believe that as our scale grows, to Greta's earlier comment, we can continue to maintain the same level of credit rigor and maintenance of our portfolio and client service without spending materially more money in absolute dollar terms.

Got it. Okay, great. And then sort of a more strategic or conceptual question. The 2 themes that sort of -- in terms of pushback that we get are slight compression and concerns about late cycle, and Greta's spoken about spreads throughout the call. I'm curious, given your collective experience, what are you guys looking for? What are the data points and signs that you're looking for to indicate the inflection in terms of credit?

Well, I can give you a couple of examples. You may have noticed that we still very much like office and multifamily. Although, our multifamily originations last year as a percentage declined slightly somewhat from the year before. And that's -- and we really do like multifamily, particularly, workforce housing and affordable housing. But what we noticed was that many of the bills that come to us nonbanks and mortgage REITs are, as you know, transitional, coming off construction lines and we noticed a trend of the proceeds level to refinance [loans of] construction loans were stressing the stabilized debt yields. So you had to make some pretty aggressive assumptions about future rate growth, to get to a stabilized debt yield that you were comfortable with. We didn't buy off on a lot of those scenarios and therefore, really declined numerous loans because we do our own underwriting and want to see a healthy stabilized debt yield. Particularly, if you think there's a chance that interest rates may rise in the next 2 to 3 years. So -- perhaps to isolate cycle phenomenon, in Manhattan, boutique hotels, we've seen a ton of request for boutique hotels, they are 100 to 200 rooms. They're often south of 42 Street, and we're seeing them run at 85% to 95% occupancy levels, yet their debt yields are 5% or less, and they're looking for par refinance or no cash and refinance, and in some cases, getting it. To me, that's a late cycle phenomenon. And it's hard to imagine how you can drive NOI and drive debt yields when you're already running around 90% occupancy. You have to count on major ADR growth. And with new construction coming online consistently or continuing to come online in Manhattan, the numbers are still pretty high. It's hard to imagine that these operators can drive room growth -- rate growth, excuse me.

(Operator Instructions) Our next question is from Ken Bruce with Bank of America Merrill Lynch.

I guess I'd like to build off of that last point that Greta was making. Maybe you could just help us reconcile, if you will, that late cycle phenomena that you're seeing with the spread compression, and is this something that you think that can persist in this backdrop? Or would you expect that independent of what you're hoping for, which is kind of addressing your prepared remarks that, is it something you would expect to start to reverse at some point?

I would expect it to start to reverse. And we saw a couple of examples, not enough of them, but examples of private debt funds that started approximately 1 to 2 years ago, who have thrown in the towel and said, we're not doing this. We can't originate at the yields we indicated to our investors and we can't cover our cost of the manager. So we would like to see that trend continue. But we -- but there are a couple of examples of that. So I do expect it to reverse. Yesterday, we were quoting a nice Class A multifamily deal and the sponsor was like, you have to tighten, your competition has tightened. And we just said, I'm sorry, we can't tighten, we've given you everything we could and we really thought we were going to lose that loan and he called us back and said, okay, send us your term sheet. So yes, we'll see.

Right. So not exactly a flight of capital, but it sounds like at least maybe there's some pause on the competition side from more money coming in?

Well, the -- if you look at some of the pension fund data that some of the research organizations put out, the fund-raising for private debt funds slowed down dramatically in the second half of 2018. The first half was very, very strong, as was 2017, but they saw a slowdown and they cited the reasons being that a lot of the LPs that invest in private equity, real estate equity and debt funds, really don't want too many different sponsors or GP relationships in the debt strategy. They -- if they have one, large one, they're not going to increase it, whereas, in equity, there's enough differentiation amongst sponsors that they could invest in numerous funds with numerous sponsors but they're less likely to in the debt fund. I hope that is the case.

Interesting. Okay, and then my only other question and thank you for all your comments this morning, but the -- you've made a curious comment just in terms of book value growth and you've kind of pointed out that you're earning and paying out your dividends. I guess, I'm just interested in kind of the thoughts around the book value growth, given kind of the nature of the mortgage REITs and how earnings gets paid out? So if you could just maybe elaborate a little bit on that, if it's -- that would be helpful.

I think, the goal is to have more [full] from dividend coverage and retained earnings and just to grow book value. And that is our goal.

Yes. So look, will -- we've been pretty clear and consistent from the get-go as to what our dividend policy, which is, we're always going to dividend not less than 100% of taxable income subject to the spill back and spill forward arrangements available in the code. And the difference is between book and tax income in our company have been largely eliminated as we move farther and farther away from the original formation transaction. So for us, building book value is a function of driving base GAAP earnings. You will see a slight increase in the spread between core and GAAP income as we move forward just as some noncash items, including stock compensation expense grow over the years. And then as we continue to issue equity prudently and at the right times, and [then] at the right values, [but] at levels above book value, that's another way to grow book value. So I hear your point, there are natural constraints to book value growth, given the dividend requirements of the code, but within that and below, we think that strong performers with strong credit quality portfolios and a stable capital base that can function in rising markets and in challenging markets, those are the platforms that, over time, will be rewarded with a book value growth and hopefully growth in trading value as well.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Well, thank you all for calling in this morning. We're very much looking forward to a productive and exciting 2019. Thank you.

This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.