KKR Real Estate Finance Trust Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. The company is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial performance and position
| Metric | Q1 2017 / Mar. 31, 2017 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $12.9 million | $6.3 million in Q1 2016 |
| Interest expense | $4.0 million | $1.2 million in Q1 2016 |
| Net interest income | $9.0 million | $5.1 million in Q1 2016 |
| Net income attributable to common stockholders | $10.4 million; $0.39 per diluted share | $0.9 million; $0.06 per share in Q1 2016 |
| Core Earnings / Net Core Earnings | $8.9 million / $8.9 million; $0.33 per weighted-average share for each | $5.9 million / $5.7 million; $0.40 / $0.38 per share in Q1 2016 |
| Total assets | $6,583.6 million | $6,265.4 million at Dec. 31, 2016 |
| Cash and cash equivalents | $153.6 million | $96.2 million at Dec. 31, 2016 |
| Commercial mortgage loans held for investment, net | $909.9 million | $674.6 million at Dec. 31, 2016 |
| Secured financing agreements, net | $586.9 million | $439.1 million at Dec. 31, 2016 |
| Stockholders’ equity / book value per common share | $646.9 million / $20.51 | $497.7 million / $20.60 at Dec. 31, 2016 |
Net cash provided by operating activities was $7.7 million; investing activities used $234.7 million, largely for loan originations and purchases; financing activities provided $284.8 million, including $147.7 million of common-stock proceeds and $147.0 million of borrowings. Cash, cash equivalents and restricted cash increased $57.8 million to $154.1 million.
The company reported $5.447 billion of commercial mortgage loans and $5.333 billion of related liabilities for consolidated variable interest entities (VIEs). These trust obligations are generally nonrecourse and the trust assets are not available to the company’s other creditors. The company’s reported debt-to-equity and total leverage ratios were each 0.7x, using its stated measure of secured debt less cash relative to stockholders’ equity.
Changes and portfolio
- Compared with Q1 2016, net interest income rose $3.8 million as the loan portfolio expanded, while interest expense also increased with additional repurchase financing.
- Net income attributable to common stockholders increased $9.5 million year over year. The improvement in other income was mainly due to a $1.5 million unrealized gain on CMBS B-Pieces in Q1 2017 versus a $4.8 million unrealized loss in Q1 2016.
- Q1 2017 Core Earnings were $8.9 million, up from $5.9 million, but Core Earnings per weighted-average share fell to $0.33 from $0.40 as the weighted-average share count increased. Management notes that Core Earnings exclude unrealized items and are non-GAAP; Q1 2017 Core Earnings also exclude $1.2 million of accreted CMBS B-Piece original issue discount included in taxable income.
- At quarter-end, the loan portfolio comprised 19 loans with $945.4 million principal and $217.3 million of unfunded commitments. Held-for-investment loans were entirely floating rate; 88.0% of investments by total assets earned floating rates. The weighted-average LTV for the total loan exposure was 67.6%.
- The weighted-average loan risk rating was 3 (Average Risk); 98.2% of held-for-investment loans were rated 3 or better, one loan was rated 4, and none were rated 5. No loans were past due or on nonaccrual, and no loan-loss allowance was recorded.
Outlook, risks and notable items
Management expects future investment activity to focus mainly on originating floating-rate senior loans financed with repurchase facilities, with a secondary focus on syndicating senior interests and retaining subordinated positions. The filing provides no quantified earnings or return guidance. Management states an intention to distribute 100% of net taxable income for the foreseeable future while retaining capital for operating needs.
- Liquidity sources at quarter-end included $153.6 million of cash and $176.6 million of available borrowings under secured facilities. The company was in compliance with financial covenants; required unrestricted cash under its liquidity covenants was at least $14.8 million.
- Repurchase financing creates collateral valuation, margin-call and refinancing risks. Facilities include credit-mark provisions, may mature before the underlying investments, and can have extension terms subject to lender discretion and covenants. A decline in collateral value could reduce available leverage or require additional cash or collateral.
- Q1 included $4.6 million of income from changes in net assets of consolidated VIEs, principally $3.1 million of net interest and a $1.5 million unrealized gain. These fair-value changes may fluctuate and should not be treated as recurring cash earnings.
- Future funding commitments on loans totaled $217.3 million, primarily for construction, property improvements and leasing costs; advances are generally subject to conditions.
- Subsequent to quarter-end, the company originated two senior loans with initial funded amounts totaling $172.5 million; amended its Wells Fargo facility to raise its maximum size to $750 million; entered a $75 million Barclays revolving facility; and used cash to repay portions of Morgan Stanley and Wells Fargo borrowings.
- After quarter-end, the company called $207.6 million of private-placement capital and completed its May 2017 IPO. The filing reports IPO net proceeds of approximately $225.9 million in its subsequent-events discussion but approximately $220.4 million in Part II, Item 2; investors should reconcile the figures.
- The April 2017 common dividend was $0.28 per share for Q1; a separate $0.25 per-share dividend for Q2 was declared in June. The $0.35 per-share dividend shown as declared during Q1 was declared in February.
- Principal risks include real estate and credit deterioration, borrower defaults, interest-rate and credit-spread movements, financing availability and costs, liquidity and margin requirements, valuation uncertainty, REIT qualification, and potential conflicts with KKR, which controls the company. Management reported no material litigation and effective disclosure controls as of March 31, 2017.
Important facts for investors to verify
- Reconcile the two different IPO net-proceeds figures disclosed in the filing and confirm the final proceeds and their use.
- Review loan-level collateral quality, the single risk-rating-4 exposure, the geographic and property-type concentrations, and the conditions and timing of the $217.3 million funding commitments.
- Assess reliance on repurchase lenders, collateral haircuts, facility maturities and extension rights, covenant headroom, and the capacity to meet potential margin calls.
- Separate recurring interest and cash earnings from Level 3 fair-value gains and the non-GAAP Core Earnings adjustments.
- Evaluate the external management agreement, management and incentive fee structure, KKR’s control and related-party arrangements, and the post-IPO capital and dividend disclosures.