TPG RE Finance Trust, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unless stated otherwise, amounts below are in U.S. dollars; financial-statement amounts are rounded to millions.
Business context
TPG RE Finance Trust is an externally managed commercial real estate finance company and REIT. It primarily originates and acquires floating-rate first mortgage loans secured by U.S. commercial properties. At quarter-end, it held 62 mortgage loans with $4.18 billion unpaid principal balance (UPB), plus four CMBS investments. The company reported that it operated as one segment.
Financial and portfolio highlights
- Q3 earnings: Net income was $26.8 million, up 29% from $20.8 million in Q3 2017. Diluted EPS was $0.42 versus $0.35. Net interest income rose to $35.6 million from $27.6 million.
- Nine-month results: Net income was $78.4 million versus $69.6 million; diluted EPS was $1.27 versus $1.34. Net interest income increased to $103.5 million from $89.8 million. Higher average share count following equity issuance contributed to the lower year-to-date EPS.
- Interest and yields: Q3 interest income was $69.9 million and interest expense was $34.3 million. The loan portfolio’s weighted-average credit spread was 4.2%, all-in yield 6.6%, and LTV 63.4% at September 30.
- Balance sheet: Total assets were $4.30 billion, including $4.16 billion of loans held for investment; total liabilities were $2.97 billion and stockholders’ equity was $1.33 billion. Loans increased from $3.18 billion at December 31, 2017.
- Debt and leverage: Outstanding borrowings totaled $2.94 billion principal, versus $2.13 billion at year-end 2017. Debt-to-equity and total leverage ratios were both 2.18x, compared with 1.71x and 1.82x, respectively. The increase reflected the new CLO and greater use of financing.
- Liquidity and cash flow: Cash and cash equivalents were $46.2 million; reported available liquidity, including undrawn financing capacity, was $311.7 million. Nine-month operating cash flow was $78.2 million, investing cash flow was negative $967.1 million, and financing cash flow was positive $859.6 million. Cash, cash equivalents and restricted cash declined $29.3 million to $46.5 million.
- Dividends and equity: The company declared $0.43 per share for Q3, or $28.9 million, and $1.28 per share for the first nine months. In August it issued 7.0 million common shares at $19.82 per share, generating $138.7 million gross proceeds. Book value per common share was $19.78, versus $19.80 at June 30.
- Credit quality and commitments: No loans were on non-accrual status or impaired, and no loan-loss allowance was recorded. The weighted-average internal risk rating was 2.8, compared with 2.6 at year-end. Unfunded loan commitments were $527.1 million.
Material changes and notable items
- In February, the company closed TRTX 2018-FL1, a $932.4 million CLO secured by mortgage assets, representing 22.3% of its loan portfolio. The CLO added non-recourse financing; the company consolidated the issuing entities as VIEs. Their creditors have recourse only to the VIE assets.
- Q3 net interest income increased year over year mainly from loan portfolio growth and higher LIBOR, partly offset by lower loan credit spreads. Interest expense also increased with higher borrowings and rates.
- Year-to-date expenses increased, mainly due to management fees and public-company costs. Q3 management and incentive fees were $4.9 million and $1.2 million, respectively. The external manager’s base fee is generally 1.50% per annum of defined equity; incentive compensation is tied to Core Earnings above a 7% annual hurdle.
- The company recorded a $0.4 million loss on a loan sale and a $0.1 million loss on CMBS sales. CMBS unrealized losses were $1.1 million for the nine-month period, recorded in other comprehensive loss; no other-than-temporary impairment was recognized.
- After quarter-end, the company closed or was in the process of closing four first mortgage loans totaling $540 million in commitments through November 5, 2018. It paid the Q3 dividend of $0.43 per share on October 25.
Outlook, risks and contingencies
- The filing gives no earnings or dividend guidance. Management described loan repayments, financing extensions, capital markets, structured financing and asset sales as possible ways to meet debt obligations; these are strategies, not assurances.
- All mortgage loans were floating-rate and generally financed with floating-rate liabilities. Net floating-rate exposure was $1.27 billion. The filing estimates that a 25-basis-point rate rise would increase annual net interest income by $3.2 million, while a 25-basis-point decline would reduce it by $2.3 million. Higher rates may also strain borrower cash flows.
- Key risks include real estate and collateral-value deterioration, borrower defaults, refinancing and funding availability, interest-rate and credit-spread movements, prepayment or extension behavior, lender margin calls, counterparty concentration, and reliance on the external manager. Financing agreements contain liquidity, net worth, leverage and interest-coverage covenants; the company reported covenant compliance at quarter-end.
- There were no material legal proceedings or recorded loss contingencies. Management reported effective disclosure controls as of September 30, 2018 and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How loan credit performance, particularly the rise in the weighted-average risk rating to 2.8 and the $213.1 million rated category 4, develops; confirm current delinquencies, impairments and collateral values.
- Whether liquidity and financing capacity remain available under lender collateral-approval, margin, maturity and covenant terms, and how the $527.1 million of unfunded loan commitments will be funded.
- How the higher leverage and the $932.4 million CLO affect funding costs, refinancing needs, recourse exposure and distributions.
- Whether loan yields and spreads adequately offset rising financing costs, and how rate floors, borrower interest-rate caps and prepayments affect reported rate sensitivity.
- How the August share issuance affects per-share earnings and book value, and whether the $0.43 quarterly dividend is supported by recurring earnings and cash generation.
- The effect of the external management and incentive-fee arrangements on expenses and shareholder returns.