KKR Real Estate Finance Trust Inc. — Q1 2018 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; comparisons are primarily with Q1 2017 unless noted. KREF is an externally managed mortgage REIT focused mainly on originating and acquiring commercial real estate loans.
Key financial results and position
| Metric | Q1 2018 / March 31, 2018 | Comparable / prior period |
|---|---|---|
| Interest income | $31.7 million | $12.9 million in Q1 2017 |
| Interest expense | $10.7 million | $4.0 million in Q1 2017 |
| Net interest income | $21.0 million | $9.0 million in Q1 2017; up 57.4% |
| Net income attributable to common stockholders | $23.3 million; $0.44 per diluted share | $10.4 million; $0.39 per diluted share in Q1 2017 |
| Core Earnings / Net Core Earnings (non-GAAP) | $18.9 million; $0.35 per diluted share | $17.1 million; $0.32 per diluted share in Q4 2017 |
| Common dividend declared | $0.40 per share | $0.35 in Q1 2017; $0.37 in Q4 2017 |
| Assets / stockholders’ equity | $7.60 billion / $1.05 billion | $7.39 billion / $1.06 billion at December 31, 2017 |
| Cash and cash equivalents | $23.1 million | $103.1 million at December 31, 2017 |
| Secured financing agreements, net | $1.28 billion | $964.8 million at December 31, 2017 |
| Book value per common share | $19.79 | $19.73 at December 31, 2017 |
| Cash flows | Operating +$18.1 million; investing −$382.3 million; financing +$283.8 million | Cash, cash equivalents and restricted cash decreased $80.4 million |
Net interest margin is not reported as a distinct metric in the filing. Reported assets and liabilities include consolidated CMBS variable-interest entities (VIEs): $5.28 billion of VIE assets and $5.16 billion of VIE liabilities at fair value. These trust liabilities are nonrecourse to KREF; they should be distinguished from the company’s secured financing agreements.
At quarter-end, the loan portfolio comprised 32 loans with $2.29 billion of outstanding face amount and $2.27 billion carrying value. Weighted-average loan coupon was 6.0%, weighted-average all-in yield 6.5%, and weighted-average LTV 67%. Approximately 94% of investments by total assets earned floating rates. The portfolio’s weighted-average internal risk rating was 2.9; 99.3% of held-for-investment loans were rated average risk or better, with none rated impaired/loss likely and none on nonaccrual or past due.
Liquidity included $23.1 million cash, $106.1 million of available borrowing under master repurchase agreements and $75.0 million under a revolving facility. The company reported debt-to-equity of 1.2x and total leverage of 1.3x, and stated that it complied with financing covenants. It had $306.6 million of future loan funding commitments and a further $22.0 million commitment to RECOP.
Material changes versus prior periods
- Common-stockholder net income rose 55.5% year over year, while net interest income increased 57.4%, mainly as KREF deployed more capital and expanded its loan portfolio.
- Interest expense rose 63.0% year over year as repurchase borrowing increased. Operating expenses increased 54.7%, reflecting higher management fees as well as $1.0 million of noncash stock-based compensation and increased public-company and operating costs.
- Other income included an $5.4 million unrealized gain on consolidated CMBS interests, compared with a $1.5 million unrealized gain in Q1 2017. Core Earnings exclude this quarter’s unrealized gain.
- Held-for-investment loans grew to $2.27 billion from $1.89 billion at year-end. Q1 loan fundings were $421.1 million and repayments were $35.0 million.
- Repurchase financing increased from $964.8 million to $1.28 billion. KREF repurchased 609,865 shares for $11.9 million during the quarter.
Outlook, commentary and risks
- Management said it expects future originations to emphasize floating-rate senior loans financed through repurchase and other term facilities; it expects CMBS B-Pieces to become a smaller share of the target portfolio over time. No specific annual earnings or revenue guidance was provided.
- Management expects to distribute 100% of net taxable income for the foreseeable future, subject to retaining capital for business needs. In May 2018, the board declared a $0.43-per-share second-quarter dividend.
- In April 2018, KREF sold its controlling beneficial interest in four CMBS trusts for $112.7 million and reported a $11.9 million gain in Q2 2018, including $5.4 million recognized as unrealized gain in Q1. It also entered a non-mark-to-market, nonrecourse term-loan facility; as of May 9, the maximum facility was $400.0 million and $306.1 million was outstanding.
- Subsequent to quarter-end, KREF originated a senior office loan in Long Island City with a maximum face amount of $350 million, of which $211.7 million was initially funded. It also funded approximately $14.7 million on previously closed loans.
- Key risks include property and borrower credit deterioration, interest-rate and credit-spread movements, financing availability and cost, and margin calls or reduced borrowing capacity if collateral values weaken. Repurchase facilities are floating-rate and not fully term-matched to the underlying loans; lender concentration is material, with Wells Fargo and Morgan Stanley net counterparty exposure together equal to 49.4% of stockholders’ equity.
- Fair values for significant loan and CMBS positions rely on Level 3 estimates and unobservable inputs. A 100-basis-point rise in credit yields was estimated to reduce net book value by approximately $6.0 million; a 50-basis-point increase in short-term rates was estimated to increase 2018 cash flows by approximately $3.0 million, based on quarter-end exposures.
- KREF reported no material litigation and no material change to its previously disclosed principal risk factors. The filing notes that adoption of the expected-credit-loss standard in 2020 is expected to result in earlier and potentially higher loan-loss provisions; no provision for loan losses was recorded at quarter-end.
Important facts for investors to verify
- Reconcile GAAP earnings with Core Earnings and assess the contribution and volatility of CMBS fair-value gains.
- Review the terms, availability, collateral haircuts, maturity extensions and counterparty exposures of financing facilities, including the post-quarter-end term-loan facility.
- Assess the $306.6 million loan-funding commitments, $22.0 million RECOP commitment and cash liquidity against the $16.1 million minimum cash covenant.
- Examine portfolio concentration, loan risk ratings, property performance and the sensitivity of Level 3 valuations to yields and collateral assumptions.
- Track the effect of the April CMBS trust sale, subsequent loan originations, share repurchases and declared dividend on leverage, liquidity and book value.
- Consider the external-management arrangement, affiliate fees and KKR’s approximately 45% ownership and associated governance influence.