KKR Real Estate Finance Trust Inc. quarterly report, Q3 FY2019

KKR Real Estate Finance Trust Inc. — Q3 2019 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2019. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. Unless noted otherwise, dollar figures below are in millions.

Key financial results

• Q3 net interest income was nearly unchanged: higher interest income from portfolio growth was largely offset by higher funding costs. For the nine months, net interest income rose 18.6% as loan balances expanded.
• Nine-month net income was lower year over year, primarily reflecting the absence of the $13.0 million gain on CMBS sales recognized in 2018 and reduced CMBS income; Q3 common earnings increased 13.4%.
• Cash from operations was $68.2 million for the nine months, versus $57.4 million a year earlier. Investing activities used $1,077.9 million, principally for loan originations; financing activities provided $997.6 million. Cash and cash equivalents fell to $74.5 million from $86.5 million at year-end.
• No operating margin metric is presented in the filing; net interest income was $28.6 million on Q3 interest income of $74.2 million.

Balance sheet, portfolio and liquidity

• Total assets were $5,211.4 million at September 30, 2019. Net commercial mortgage loans held for investment were $5,077.0 million, up from $4,001.8 million at December 31, 2018.
• Loan portfolio: 38 loans, $5,106.4 million face amount, 99.9% floating rate, 5.3% weighted-average coupon, 67% average LTV and 3.8-year weighted-average life. All loans were risk-rated 3 or better; none were past due or on nonaccrual.
• Multifamily accounted for 54.1% of loan collateral by face amount and New York for 27.1%, indicating property-type and geographic concentrations.
• Debt-related balance-sheet liabilities included $3,038.6 million of secured financings, $802.7 million of CLO debt, $138.7 million of convertible notes and $65.0 million of loan participations sold. Debt-to-equity was 2.0x and total leverage was 3.6x, versus 1.1x and 2.6x at year-end 2018.
• Reported liquidity sources totaled $270.2 million: $74.5 million cash and $195.7 million available borrowing capacity. The company was required to maintain at least $39.2 million of unrestricted cash under financing covenants and reported compliance with its debt covenants.
• Book value was $19.54 per share, down from $19.66 at year-end 2018. Stockholders’ equity was $1,122.0 million.

Material changes, outlook and risks

• Portfolio growth and financing expansion drove higher interest income and expense. Secured financing agreements rose to $3.039 billion from $1.951 billion at year-end; KREF added a $900 million non-mark-to-market Term Lending Agreement in June 2019 and expanded its revolving facility to $250 million.
• Non-mark-to-market financing represented 74% of portfolio financing at quarter-end. However, repurchase facilities carry credit-mark provisions that can reduce borrowing capacity or require additional collateral if collateral values decline; some financing may mature before underlying loans.
• KREF sold its remaining directly held CMBS investments during Q3 for $9.8 million, recording a $0.4 million loss, and deconsolidated the related CMBS trust. In October, it acquired $94.0 million of investment-grade CMBS as part of a new cash-management strategy.
• Management expects to distribute 100% of net taxable income for the foreseeable future. The $0.43 common dividend was maintained in Q3; no earnings or EPS guidance was provided.
• About half of the loan portfolio had LIBOR floors of 2.0% or higher. Management estimated a 50-basis-point LIBOR decline would increase expected cash flows by approximately $6.6 million over the following 12 months, compared with an estimated $0.5 million increase from a 50-basis-point rise. Financing costs also float, so net effects depend on asset and liability repricing.
• LIBOR was expected to be discontinued after 2021. Nearly all loans and financing arrangements were LIBOR-linked; contracts included alternative-rate procedures, but management could not assure the replacement rate or transition impact.
• Future loan funding commitments were $551.8 million, primarily for construction, property improvements and leasing costs. These are generally conditional on borrower and project requirements.
• Management expected adoption of the CECL credit-loss standard in Q1 2020 to increase provisions for potential loan losses and recognize them earlier in the credit cycle; no loan-loss provision was recorded at September 30, 2019.
• Other key risks include real estate collateral deterioration, borrower defaults, interest-rate and credit-spread changes, funding availability and margin calls. No material legal proceedings or material changes to previously disclosed principal risk factors were reported.

Important facts for investors to verify

1. Whether portfolio growth can sustain net interest income as funding costs rise and leverage increases.
2. Collateral performance and concentrations, including multifamily exposure, New York exposure and the large share of loans rated average risk.
3. Liquidity available after accounting for the $551.8 million of conditional funding commitments, dividend needs and potential financing margin calls.
4. Debt maturities, extension conditions, counterparty exposures and the potential effects of LIBOR transition and CECL adoption.
5. Dividend coverage and book-value effects, including the redeemable preferred-stock adjustment and incentive compensation arrangements with the KKR-affiliated manager.