KKR Real Estate Finance Trust Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. Unless stated otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $40.4 million | $17.4 million | $72.1 million | $30.4 million |
| Interest expense | $18.8 million | $3.2 million | $29.5 million | $7.2 million |
| Net interest income | $21.6 million | $14.2 million | $42.6 million | $23.2 million |
| Net income attributable to common stockholders | $23.5 million | $14.1 million | $46.8 million | $24.4 million |
| Diluted EPS | $0.44 | $0.30 | $0.88 | $0.66 |
| Common dividend declared per share | $0.43 | $0.53 | $0.83 | $0.88 |
Q2 included a $13.0 million realized gain from selling controlling interests in four CMBS trusts. The quarter also recorded a $6.4 million loss from changes in net assets of consolidated VIEs, including unrealized and reversal items. KREF reported supplemental non-GAAP Core Earnings and Net Core Earnings of $37.5 million, or $0.71 per diluted share, for Q2; these measures include adjustments and are not substitutes for GAAP earnings. No conventional operating margin is presented in the filing.
Portfolio, balance sheet, cash flow and liquidity
- At June 30, 2018, assets were $4.03 billion, versus $7.39 billion at year-end 2017; the decline principally reflects the sale and deconsolidation of CMBS trusts. Commercial mortgage loans held for investment were $2.84 billion, up from $1.89 billion.
- Loan portfolio: 35 loans, with $2.86 billion face amount and $2.84 billion carrying value. The weighted-average coupon was 6.0%, weighted-average life 3.8 years, and average risk rating 2.9. Management reported 99.4% of loans rated average risk or better, no loans past due or on nonaccrual, and no portfolio impairments.
- Loans were concentrated in office properties (53.8% of carrying value) and New York collateral (33.0%). Approximately 98% of investments by total assets earned floating rates.
- Cash and cash equivalents were $40.8 million, down from $103.1 million at year-end. Reported available liquidity, including cash and available facility borrowings, was $280.5 million. The filing states that at least $14.9 million of cash was required for financing liquidity covenants.
- Secured financing agreements, net, were $1.63 billion; convertible notes, net, were $137.0 million; loan participations sold were $81.5 million. Separately presented VIE liabilities were $1.10 billion and are generally nonrecourse to KREF. Debt-to-equity was 1.2x and total leverage was 1.8x, versus 0.8x and 1.0x at year-end 2017. KREF was in compliance with stated financial covenants.
- For the first six months, operating cash flow was $34.1 million, investing cash outflow was $842.9 million, and financing cash inflow was $746.1 million; cash, cash equivalents and restricted cash declined $62.8 million.
- Book value per common share was $19.82, compared with $19.73 at year-end 2017. KREF repurchased 687,809 shares for $13.4 million during the first half.
Material changes and management commentary
- Year-over-year Q2 net interest income increased 51.6%; first-half net interest income increased 83.7%. Management attributed growth primarily to a larger deployed investment portfolio, partly offset by higher financing costs.
- In April, KREF sold its controlling beneficial interests in four of five CMBS trusts for $112.7 million, recognizing a $13.0 million gain. Management expects future investment activity to focus mainly on floating-rate senior loans, with CMBS B-Pieces representing a smaller share over time.
- In April, KREF entered a term-loan financing facility, increased to $600 million of capacity by quarter-end. It provides non-mark-to-market, nonrecourse asset-based financing with matched terms of up to five years. In May, KREF issued $143.75 million of 6.125% convertible notes due in 2023.
- Quarterly common dividends increased sequentially from $0.40 to $0.43 per share. KREF expects to begin paying incentive compensation to its Manager in Q3; it estimated an additional $2.4 million tied to the CMBS-sale gain.
- After quarter-end, KREF originated two senior loans with maximum face amounts totaling $415.5 million, received approximately $130.7 million of loan repayments, and entered a $200 million financing facility with partial recourse. The Q2 dividend of $0.43 per share was paid in July.
Outlook, risks and contingencies
- No quantified earnings or revenue guidance is provided. Management expects continued emphasis on floating-rate senior lending and states that rising short-term rates would generally increase net income, while falling rates would generally reduce it. A 50-basis-point rate increase or decrease was estimated to change 2018 cash flows by approximately $3.5 million in either direction, based on June 30 exposures.
- Key risks include borrower defaults and deterioration in collateral property performance or value; interest-rate and credit-spread movements; refinancing and funding availability; and potential margin calls under repurchase facilities. Repurchase lenders may revalue collateral and require additional collateral or repayment, affecting liquidity.
- Future loan funding commitments were $422.9 million, primarily for construction, capital improvements and leasing costs; $219.9 million was scheduled within one year. KREF also had an $18.0 million remaining RECOP investment commitment.
- Management reported no material legal proceedings and no material changes to previously disclosed principal risk factors. KREF expects to distribute 100% of net taxable income for the foreseeable future, while retaining capital for ongoing needs. Adoption of the expected-credit-loss standard was anticipated to increase and accelerate recognition of loan-loss provisions; no provision was recorded at June 30, 2018.
- Fair-value estimates for significant loan and CMBS positions rely on Level 3 inputs and management judgment. The filing cautions that actual results may differ from estimates and forward-looking statements.
Important facts for investors to verify
- How much of Q2 and first-half earnings reflects recurring lending income versus the $13.0 million CMBS-sale gain and other fair-value movements?
- Whether portfolio growth, rising funding costs and increased leverage support sustainable net interest income and the dividend.
- Available liquidity after funding the $422.9 million of loan commitments, and the potential effect of collateral revaluations or margin calls.
- Credit performance and concentration in office assets and New York, including developments in the loan rated high risk.
- The impact of the expected $2.4 million Manager incentive fee, related-party arrangements, and the economics and recourse terms of financing facilities.