Business context and reporting period
KKR Real Estate Finance Trust Inc. (KREF) is an externally managed mortgage REIT focused primarily on originating and acquiring transitional commercial real estate loans. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2023; comparisons are to the corresponding 2022 periods unless noted.
Financial and operating highlights
- Second-quarter results: Net interest income was $44.0 million, versus $45.9 million a year earlier. KREF reported a $20.1 million net loss and a $25.8 million loss attributable to common stockholders, or $(0.37) per diluted share; a year earlier it reported $25.0 million net income and $19.4 million attributable to common stockholders, or $0.28 per diluted share.
- First-half results: Net interest income increased to $90.5 million from $86.6 million. Net loss was $45.4 million and loss attributable to common stockholders was $56.6 million, or $(0.82) per diluted share, compared with net income of $60.4 million and common-stockholder income of $49.2 million, or $0.75 per basic share, in 2022.
- Credit costs: Credit-loss provision was $56.3 million in Q2 and $116.8 million for the first half, compared with $11.8 million and $10.6 million, respectively, in 2022. The June 30 allowance was $223.8 million on loans, plus $4.1 million for unfunded commitments, up from $107.0 million and $4.1 million at year-end 2022.
- Distributable earnings: Management’s non-GAAP measure was $33.1 million, or $0.48 per diluted share, in Q2, nearly unchanged from Q1. The declared common dividend was $0.43 per share. Distributable earnings are not a substitute for GAAP results and exclude unrealized credit-loss provision.
- Portfolio: KREF reported $7.49 billion of loan principal across 71 loans; 99% of loans held for investment were floating rate. Average portfolio risk rating was 3.2. Ratings 4 and 5 represented approximately 10% and 7% of total loan exposure, respectively. Multifamily and industrial loans together comprised 56% of the portfolio.
- Cash flow: First-half operating cash flow was $77.1 million, compared with $68.4 million in 2022. Investing activities provided $59.4 million, versus $1.14 billion used in 2022, as loan originations and fundings fell to $374.6 million from $1.79 billion and repayments were $435.2 million versus $647.8 million. Financing activities used $164.2 million; cash, cash equivalents and restricted cash declined $27.7 million to $222.9 million.
- Debt and liquidity: Total liabilities were $6.15 billion and equity was $1.46 billion at June 30. Reported total financing, including non-consolidated senior interests, was $6.38 billion. Cash and cash equivalents were $207.7 million; available borrowings were $591.9 million, for reported primary liquidity of $799.6 million. KREF also had $18.0 million of unencumbered senior loans available to pledge, subject to lender approval. Debt-to-equity was 2.2x and total leverage was 4.0x, versus 2.0x and 3.8x at December 31, 2022.
- Equity and dividends: Book value per common share fell to $16.38 from $18.00 at year-end; management attributed $3.30 per share of the June value to the estimated CECL allowance. Common dividends declared were $0.43 per share in each quarter. The $143.75 million convertible notes matured and were repaid in cash in May; none remained outstanding.
Material changes and management commentary
- For the first half, interest income rose 91% to $312.2 million, but interest expense rose 187% to $221.7 million as market rates and average borrowings increased. The $106.2 million year-over-year increase in credit-loss provision was the principal driver of the swing from first-half profit to loss.
- Management said rising rates generally benefit KREF’s net income, but may also weaken property values and borrowers, increase financing costs, slow repayments and prompt borrowers to extend loans. KREF reported collecting 99.4% of loan interest payments due in the first half; some nonaccrual-loan collections were applied against loan cost rather than recognized as income.
- Three risk-rated 5 senior office loans were highlighted: Mountain View was placed on nonaccrual in June; the Minneapolis loan was restructured in June and its senior loan placed on nonaccrual; and the Philadelphia loan remained on nonaccrual. The filing cites challenged office leasing markets and collateral-dependent loss estimates as factors in reserves.
- KREF modified loans in Philadelphia, West Hollywood and Minneapolis during the period. Terms included repayment, restructuring, additional or subordinated notes, and, for the Minneapolis mezzanine note, payment-in-kind interest.
- Future loan funding commitments were $1.195 billion, primarily for construction, capital improvements, tenant improvements and leasing costs. Financing maturities and extension conditions, possible collateral-related margin calls, and substantial exposure to CRE collateral are relevant liquidity and credit risks.
Outlook, risks and contingencies
The filing provides no numerical earnings or dividend guidance. Management stated that available liquidity was expected to meet anticipated short- and long-term financing, operating and other requirements under current conditions. KREF was in compliance with its financing covenants at June 30, 2023. It reported no material legal proceedings and no material changes to previously disclosed risk factors. Principal risks include CRE valuation and leasing weakness, particularly office; borrower defaults and extensions; higher rates and funding costs; lender or market disruption; and potential restrictions on financing availability. Management also noted that nearly all cash deposits exceeded insured limits, though deposits were diversified among financial institutions.
Important facts for investors to verify
- How the three risk-rated 5 office loans perform, including collateral values, restructurings, nonaccrual status and eventual realized losses.
- Whether the $223.8 million loan-loss allowance and the $3.30-per-share book-value impact adequately reflect expected credit losses and future economic conditions.
- Whether distributable earnings can sustain the $0.43 quarterly common dividend, given the GAAP loss and the non-GAAP measure’s exclusions.
- Whether available liquidity, covenant headroom and refinancing capacity remain adequate as facilities mature and $1.195 billion of future loan commitments are funded.
- How higher rates, office demand, borrower extensions and CRE values affect portfolio income, collections and collateral-related financing requirements.