KKR Real Estate Finance Trust Inc. quarterly report, Q2 FY2020

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KKR Real Estate Finance Trust Inc. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. Unless stated otherwise, dollar amounts below are in millions.

Financial performance and position

  • Q2 earnings: Interest income was $67.2; interest expense was $30.6, producing net interest income of $36.7, up 41.8% from $25.9 in Q2 2019. Net income attributable to common stockholders was $28.6, or $0.52 per share, compared with $17.4, or $0.30 per share, a year earlier. Core Earnings, a non-GAAP measure, were $25.0, or $0.45 per diluted share.
  • First-half earnings: Net interest income rose 23.1% to $68.7 from $55.8 in H1 2019. KREF reported a common-stockholder loss of $6.6, or $0.12 per share, versus income of $42.1, or $0.73 per share, principally reflecting $53.9 of credit-loss provision expense in 2020. The filing does not provide a single net interest margin figure.
  • Balance sheet: Total assets were $5,235.6 at June 30, versus $5,057.0 at year-end 2019. Commercial mortgage loans, net, were $5,051.1 after a $62.4 allowance for credit losses. Cash and cash equivalents were $127.3, including $8.0 held in the CLO. Stockholders’ equity was $1,030.2; book value per share was $18.57, down from $19.52 at year-end.
  • Portfolio and credit: Total loan exposure was $5,221.1 across 39 loans, with $512.0 of unfunded commitments. The portfolio was 99.9% floating-rate; multifamily and office represented 81% of the portfolio. Average risk rating increased to 3.1 from 2.9 at year-end; 16.0% of exposure was rated 4 and 0.1% rated 5. Management reported 99.9% of the loan portfolio performing and collected 99.8% of interest due in Q2 and in July.
  • Debt and leverage: Reported financing liabilities included $3,152.7 of secured financing, $806.6 of CLO debt, $139.8 of convertible notes and $65.0 of loan participations sold. Debt-to-equity was 2.1x and total leverage was 4.0x, versus 1.9x and 3.5x, respectively, at year-end. KREF reported compliance with its debt covenants.
  • Liquidity and cash flow: Cash was $127.3. The company reported $431.1 of liquidity sources, including $285.0 available under its corporate revolver and other available borrowing capacity. For H1, operating cash flow was $53.0, investing cash outflow was $177.8, and financing cash inflow was $184.4; cash increased $59.6.
  • Dividends and repurchases: KREF declared $0.43 per common share for Q2, unchanged year over year, and paid the $23.9 total dividend in July. It repurchased 2.04 million shares during H1 for $25.0 at an average $12.27 per share.

Material changes versus comparable periods

  • Q2 net interest income and common-stockholder earnings increased year over year, supported by portfolio growth, lower interest expense and loan LIBOR floors.
  • H1 results shifted from common-stockholder income of $42.1 in 2019 to a loss of $6.6 in 2020. KREF adopted CECL on January 1, recording a $15.0 opening-equity adjustment, then recognized $53.9 of H1 credit-loss provision expense as the economic outlook weakened. The Q2 provision was a $1.4 reversal.
  • Portfolio average risk rating rose from 2.9 at December 31, 2019 to 3.1 at June 30, and leverage increased. Book value per share declined by $0.95.
  • Interest income increased as the loan portfolio expanded, while lower market LIBOR benefited loans with floors. KREF noted that most loan assets and financing liabilities are floating-rate and LIBOR-linked.

Outlook, risks and unusual items

  • Management gave no quantified earnings or portfolio guidance. It warned that COVID-19 could materially worsen financial performance, revenue, cash flow or profitability in one or more remaining 2020 periods compared with prior-year periods and earlier expectations.
  • Two hotel loans with $216.9 of principal were modified in Q2. Changes included borrower capital contributions, reserve reallocations and temporary partial coupon deferrals capitalized as PIK interest; the modifications were not classified as troubled debt restructurings. A $5.5 mezzanine loan was placed on nonaccrual and $4.7 was written off.
  • COVID-19 risks include borrower and tenant stress, lower occupancy and rents, defaults, declining collateral values, increased credit losses, delayed investment redeployment and reduced access to or higher costs of financing. Hospitality and retail borrowers were among those experiencing pressure; multifamily and office were the largest portfolio sectors.
  • Repurchase facilities have credit mark-to-market provisions that may require additional collateral or repayment if loan collateral values deteriorate. Management reported no margin calls to date. Future loan funding commitments of $512.0 and a $4.3 RECOP I commitment are additional liquidity needs.
  • LIBOR was expected to be discontinued after 2021. Nearly all loans and financing arrangements were LIBOR-linked; contracts provide for alternative-rate procedures, but the effect of transition is uncertain.
  • KREF said it expected to distribute at least 90% of 2020 REIT taxable income, while continuing to reassess capital and liquidity needs amid pandemic uncertainty. No material litigation was reported.

Important facts for investors to verify

  • How CECL assumptions, collateral values and borrower conditions evolve, and whether the $64.3 total allowance (including unfunded commitments) proves sufficient.
  • Performance, payment status and risk-rating trends for loans rated 4 or 5, hotel modifications, and the written-off mezzanine loan.
  • Actual available liquidity after funding commitments, dividend payments and any collateral calls; confirm revolver availability and covenant headroom.
  • Refinancing and maturity exposure across facilities, including near-term maturities and the effect of LIBOR replacement on asset-liability spreads.
  • Whether dividends remain sustainable given pandemic impacts, REIT distribution requirements and management’s stated uncertainty about 2020 results.
  • Reconcile the filing’s reported liquidity and leverage measures with underlying debt balances, collateral restrictions and the definitions used for each measure.