KKR Real Estate Finance Trust Inc. — Q2 2017 Form 10-Q
Business and period: Unaudited quarter and six months ended June 30, 2017. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. The quarter included the company’s May 2017 IPO and a substantial increase in its equity base.
Financial performance and position
- Q2 earnings: Net interest income was $14.2 million, up from $5.5 million in Q2 2016. Net income attributable to common stockholders was $14.1 million versus $8.9 million; diluted EPS was $0.30 versus $0.51. The lower EPS despite higher earnings primarily reflects the increase in weighted-average shares to 46.6 million from 17.2 million.
- First-half results: Net interest income was $23.2 million versus $10.6 million; common-stockholder net income was $24.4 million versus $9.7 million; diluted EPS was $0.66 versus $0.60.
- Other income and expenses: Q2 other income was $4.8 million, down from $5.8 million a year earlier, principally reflecting a smaller unrealized gain on CMBS B-Pieces. First-half other income rose to $9.6 million from $3.8 million, including a $2.6 million unrealized gain on CMBS B-Pieces versus a $2.1 million unrealized loss in the prior-year period. Q2 management fees to the affiliate increased to $3.5 million from $1.3 million.
- Cash flow: For the six months, operating cash flow was $22.6 million, investing cash outflow was $358.0 million, and financing cash inflow was $296.9 million. Cash, cash equivalents and restricted cash ended at $57.9 million, down $38.4 million from year-end. Investing outflows included $416.6 million of loan originations and purchases; financing included $581.3 million in common-stock issuance proceeds and $460.4 million in debt repayments.
- Balance sheet and liquidity: Total assets were $6.63 billion and total liabilities $5.55 billion at June 30. Cash and cash equivalents were $57.0 million. Secured financing agreements were $177.2 million net carrying value ($183.2 million face amount); available borrowing capacity was reported at $537.2 million under secured debt arrangements and $75.0 million under the Barclays revolving facility. Reported debt-to-equity and total leverage ratios were 0.1x and 0.2x, respectively.
- Debt presentation: The $5.35 billion of consolidated variable-interest-entity liabilities relates to CMBS trusts and is generally nonrecourse to KREF; it should not be read as ordinary corporate recourse debt. The trusts’ assets are likewise separately presented and restricted to settling their obligations.
- Portfolio and equity: Held-for-investment commercial mortgage loans totaled $1.06 billion across 21 loans, with a 6.2% weighted-average all-in yield and 3.9-year weighted-average life. Average loan risk rating was 2.9; 98.5% of held-for-investment loans were rated average risk or better. Stockholders’ equity was $1.07 billion and book value was $19.83 per share, versus $20.51 at March 31.
- Distributions: Common dividends declared were $0.53 per share during Q2, comprising a $0.28 distribution related to Q1 and a $0.25 Q2 distribution. The latter, totaling $13.4 million, was paid in July.
Changes, outlook and risks
- Loan portfolio carrying value increased from $674.6 million at December 31, 2016 to $1.06 billion at June 30, reflecting originations and purchases. The company completed its IPO in May and issued 11.8 million shares at $20.50 per share. Management attributed earnings growth chiefly to deploying additional capital into investments.
- Management expects future investment activity to emphasize floating-rate senior loans financed with repurchase facilities; it expects the portfolio share of CMBS B-Pieces to decline over time. The filing provides no quantitative earnings or dividend guidance.
- After quarter-end, KREF originated three senior loans with $391.5 million initially funded, and borrowed $342.1 million under Wells Fargo and $71.1 million under Morgan Stanley repurchase facilities. It also reported approximately $5.0 million of subsequent funding for previously closed loans.
- At June 30, unfunded loan commitments were $256.7 million, primarily for property construction and improvements; a further $36.0 million remained committed to RECOP. These obligations may require future liquidity, subject to contractual conditions.
- Key risks include borrower defaults and collateral-value declines; interest-rate and credit-spread movements; repo-facility mark-to-market, margin-call and refinancing risk; and dependence on access to financing. A 50-basis-point short-term rate increase or decrease was estimated to change 2017 cash flows by approximately $1.6 million in the corresponding direction. A 100-basis-point increase in credit yields was estimated to reduce net book value by $6.0 million.
- Management reported no loans past due or on nonaccrual, no loan impairments or loss allowances, and no defaults or delinquencies in loans underlying CMBS B-Pieces. One loan was rated high risk/potential for loss; none was rated impaired/loss likely. No material legal proceedings were reported, and KREF was in compliance with financial loan covenants.
- KREF is externally managed by a KKR affiliate and pays management fees under the management agreement; KKR controls the company, and the filing notes potential conflicts of interest. The company expects to distribute 100% of net taxable income for the foreseeable future, while retaining capital for ongoing needs.
Important facts for investors to verify
- How the post-IPO equity base and expanded loan portfolio affect recurring earnings per share, book value per share and dividend coverage.
- Liquidity available after funding the $256.7 million loan commitments and $36.0 million RECOP commitment, including the terms and actual availability of borrowing facilities.
- The distinction between nonrecourse consolidated CMBS liabilities and KREF’s recourse borrowings, and the potential impact of repo margin calls or facility renewals.
- Performance and valuation of Level 3 assets, including CMBS B-Pieces, and the status of the single high-risk loan.
- Affiliate management fees, governance protections and potential conflicts, as well as the effect of REIT distribution requirements on retained capital.