TPG RE Finance Trust: The Preferreds Are A Buy As Rate Cuts Loom (NYSE:TRTX)

The 26% rally over the last 1 year of TPG RE Finance Trust’s (NYSE:TRTX) commons to $8.50 needs to be contextualized against a book value of $11.40 per share as of the end of its fiscal 2024 second quarter. The mortgage REIT owns debt collateralized by US real estate, with a heavy focus on multifamily properties. Total loan commitments stood at $3.3 billion at the end of its second quarter with 52.5% allocated to multifamily and an 18.4%% allocation to office properties the second largest position. The rally has been built on the perceived reduction of the inherent risk of TRTX’s loan book as the mREIT pushes through a decrease in its office allocation. The second quarter saw $116.3 million in new multifamily loan originations against full repayments of $373.8 million.

Roughly a quarter of repayments were office loans with TRTX allowing repayments to run ahead of investments by $257.5 million, leading to a surge in cash and equivalents and a material reduction in the mREIT’s leverage ratios. Debt-to-equity is down to 2.02x from 2.6x three quarters ago, bolstering the safety of the commons and making an extremely bullish case for a position in the mREIT’s 6.25% Series C Preferreds (NYSE:TRTX.PR.C).

The preferreds are also cumulative, meaning any unpaid dividends accrue as a liability for later repayment. The fundamental creditworthiness of TRTX and the value of its commons and preferreds have been boosted by the dual impact of an increase in liquidity and a reduction in leverage with cash-on-hand available for investment of $244.2 million at the end of the second quarter set to drive future growth on rate cuts.

Floating Rate Loans And The Reduction In Office

The market is confident of the September 18th FOMC meeting being the first cut to the Fed funds rate since rates started being hiked in 2022 with the CME FedWatch Tool placing the probability of a cut at 100%. The impact of this on TRTX will be multifaceted with the mREIT set to lose $0.01 per share in portfolio net interest income for every 50 basis point dip in Term SOFR which tracks the Fed funds rate. 99.7% of the mREIT loans are floating rate and with a weighted average all-in yield of 9.3%.

Hence, TRTX is set to see a period of net interest income dipping in the event consumer inflation continues to fall towards the Fed’s 2% target. The mREIT generated a second-quarter GAAP net income of $21 million, around $0.26 per share, a huge improvement from a GAAP net loss of $72.7 million a year ago. The year-ago period was affected by an increase in CECL expense of $81.3 million. Distributable earnings of $22.3 million, around $0.28 per share, covers the common share dividend of $0.24 per share by 117%, heightening its safety as net interest income is set to face downward pressure in the shadow of rate cuts.

TRTX’s success story over the last three years has been the material reduction in its office loans, an asset class that has rapidly fallen out of favor with investors as work-from-home has become the status quo. The mREIT still holds $614.5 million in office loans as of the end of its second quarter, down from $2.27 billion in the fourth quarter of its fiscal 2021. This fell as a percent of total loans by 200 basis points sequentially during the second quarter, with a dip to single digits possible in the third quarter of fiscal 2025 if the current trajectory is maintained.

Loan Portfolio Walk And Preferred Discount

The mREIT can lean on an expansion of its loan portfolio to counter the impact of falling rates. TRTX’s loan portfolio has been falling for the last few years. A continued dip in the loan portfolio when the Fed has pushed through several 25 basis point cuts would likely place the common share dividend at risk even with the mREIT’s liquidity at a healthy level.

The mREIT’s strategy has been conservative, retaining liquidity and reducing leverage. This has paid off immensely but there will likely need to be a switch soon to a more aggressive stance while still being selective on the types of loans being originated. I hold a significant position in the preferreds, with rate cuts set to see their value rise, they’re up $1 since I last covered the mREIT. However, at $17.95 per share, they’re trading at a 28% discount to liquidation value with an 8.7% yield on cost.