KKR Real Estate Finance Trust Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. Comparisons below are with Q3 and the first nine months of 2016 unless otherwise noted. Dollar amounts are in millions except per-share figures.
Financial results and key metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Interest income | $24.4 | $7.9 | $54.8 | $20.9 |
| Interest expense | $5.4 | $1.6 | $12.6 | $4.0 |
| Net interest income | $19.0 | $6.3 | $42.2 | $16.9 |
| Other income | $4.3 | $6.3 | $13.9 | $10.1 |
| Operating expenses | $5.3 | $2.2 | $12.8 | $6.2 |
| Net income attributable to common stockholders | $17.3 | $10.0 | $41.8 | $19.7 |
| Diluted EPS | $0.32 | $0.48 | $0.98 | $1.12 |
| Dividends declared per common share | $0.37 | $0.26 | $1.25 | $0.95 |
- Growth and balance sheet: Total assets were $7.16 billion at September 30, versus $6.27 billion at year-end 2016. Stockholders’ equity was $1.062 billion. Cash and cash equivalents were $90.0 million, with $0.6 million of restricted cash.
- Portfolio: Held-for-investment commercial mortgage loans were $1.544 billion net; held-for-sale loans were $81.6 million. The company reported a $1.812 billion diversified investment portfolio using its stated portfolio measure. Loan exposure included 26 loans, with a weighted-average cash coupon of 5.8%, all-in yield of 6.3%, and weighted-average maximum maturity of 3.8 years. 92.3% of investments by total assets earned floating rates.
- Debt and liquidity: Secured financing agreements had $761.6 million outstanding face amount and $756.0 million carrying value. Debt-to-equity was 0.6x and total leverage was 0.7x. KREF reported $437.6 million of available borrowings under secured debt arrangements and $75.0 million under its revolving facility, in addition to cash. It was in compliance with financial covenants.
- Consolidated VIEs: The balance sheet included $5.43 billion of CMBS-trust loan assets and $5.31 billion of related fair-value liabilities. These obligations are generally nonrecourse and the trust assets are not available to KREF’s other creditors; they materially enlarge reported assets and liabilities.
- Cash flow, nine months: Operating cash flow was negative $43.9 million; investing cash flow was negative $811.5 million, principally reflecting loan originations and purchases; financing cash flow was positive $849.6 million, including $581.3 million of common-stock proceeds and net borrowing activity. Cash, cash equivalents and restricted cash declined $5.8 million to $90.6 million.
- Book value: Book value per common share was $19.78 at September 30, compared with $19.83 at June 30.
Material changes versus comparable periods
- Net interest income rose $12.7 million in Q3 and $25.3 million for the nine-month period, primarily because KREF deployed more capital into investments; increased financing costs partly offset the growth.
- Common-stockholder net income increased, but diluted EPS fell from $0.48 to $0.32 in Q3 and from $1.12 to $0.98 for the nine months. The weighted-average diluted share count increased substantially following equity raises and the May 2017 IPO.
- Q3 other income declined $2.0 million year over year, principally because unrealized gains on CMBS B-Pieces were lower than in Q3 2016. Nine-month other income increased $3.8 million, including higher unrealized gains and income from new equity-method investments.
- Operating expenses increased with management fees, the larger equity base, and public-company costs. Management fees were $4.0 million in Q3 and $9.5 million for the nine months.
- Held-for-investment mortgage loans grew to $1.544 billion from $674.6 million at year-end 2016. Common shares outstanding rose to 53.7 million from 24.2 million over the same dates, reflecting private-placement capital calls and the IPO.
Outlook, risks and unusual items
- No quantified earnings or dividend guidance was provided. Management said it expects future investment activity to emphasize floating-rate senior loans financed through repurchase facilities, with CMBS B-Pieces expected to become a smaller share of the target portfolio over time. The company expects to distribute 100% of net taxable income for the foreseeable future, subject to capital needs.
- Management reported no loans on nonaccrual or past due and no investments rated 5 (impaired/loss likely). The weighted-average loan risk rating was 3.0; 99.0% of held-for-investment loans were rated 3 or better. No delinquencies were reported in loans underlying CMBS B-Piece investments. One loan was rated 4.
- Key risks include borrower/property credit deterioration, real estate and credit-market volatility, higher financing costs, funding and refinancing availability, and repurchase-agreement collateral marks or margin calls. A 100-basis-point increase in credit yields was estimated to reduce net book value by about $6.1 million. A 50-basis-point rise in short-term rates was estimated to increase 2017 cash flows by about $2.9 million, based on the September 30 portfolio and net floating-rate exposure.
- Repurchase financing is floating-rate and not fully term-matched to loan assets. KREF reported $286.7 million of future loan-funding commitments and a further $32.0 million commitment to RECOP. Repurchase counterparties Wells Fargo and Morgan Stanley represented net counterparty exposure equal to 57.3% of stockholders’ equity in aggregate, as calculated in the filing.
- After quarter-end, KREF originated a $133.5 million-funded floating-rate senior loan in North Bergen, New Jersey, and funded about $8.2 million on previously closed loans. It borrowed $75.0 million under the Morgan Stanley facility and amended the Goldman Sachs facility, increasing its maximum size from $250 million to $400 million. The Q3 common dividend of $0.37 per share was paid in October.
- The August repayment of a preferred-interest investment returned $37.3 million and included a $1.1 million guaranteed minimum return recorded as interest income. The filing reported no material legal proceedings and no material changes to previously disclosed principal risk factors.
Important facts for investors to verify
- Reconcile reported GAAP assets and liabilities with the large, nonrecourse CMBS VIE balances, and distinguish them from KREF’s recourse and secured financing exposure.
- Assess whether portfolio growth and net interest income can support per-share earnings and dividends as the substantially larger post-IPO share base seasons.
- Review the $286.7 million of loan funding obligations, the $32.0 million RECOP commitment, and liquidity available after those funding needs and dividends.
- Monitor floating-rate asset and liability repricing, lender advance rates, collateral marks, facility maturities and potential margin calls.
- Examine loan concentration and credit quality, including the 67% weighted-average LTV, geographic/property exposures, and the single risk-rating-4 loan; these measures do not eliminate potential losses.
- Evaluate the valuation sensitivity of Level 3 loans and CMBS-related interests, the management-fee arrangement with KKR affiliates, and the effect of repurchases and dividend distributions on book value and capital.