KKR Real Estate Finance Trust Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring transitional commercial real estate loans.
Financial performance and position
- Q3 earnings: Interest income was $114.6 million and interest expense was $67.3 million, producing net interest income of $47.3 million, up 4.0% from $45.5 million in Q3 2021. A net credit-loss provision of $80.6 million drove a GAAP net loss attributable to common stockholders of $48.4 million, or $0.70 per share, versus net income of $32.0 million, or $0.57 per share, a year earlier.
- Distributable Earnings (non-GAAP): Q3 was $34.4 million, or $0.50 per diluted share, versus a $0.43 common dividend per share. Management describes this measure as an indicator of dividend-paying capacity; it is not a substitute for GAAP earnings.
- Nine-month results: Net interest income rose 8.9% to $134.0 million. Net income attributable to the company was $17.8 million and net income attributable to common stockholders was $0.8 million, or $0.01 per share, compared with $90.4 million, or $1.63 per share, in the 2021 period. The year-over-year deterioration principally reflects $91.2 million of net credit-loss provisions versus a $1.0 million reversal in 2021.
- Portfolio and credit reserves: Commercial real estate loan carrying value, net of allowance, was $7.20 billion; the allowance for loan losses was $110.8 million, up from $22.2 million at year-end 2021. Including reserves for unfunded commitments, total allowance was $114.9 million. Average portfolio risk rating worsened to 3.1 from 2.9; risk-rated 4 and 5 exposures were 11.2% of total loan exposure. All three risk-rated 5 loans were office-related.
- Balance sheet and leverage: Total assets were $7.54 billion and permanent equity was $1.60 billion. Debt carrying amounts included $3.47 billion of secured financing, $1.93 billion of CLO obligations, a $337 million secured term loan and $143 million of convertible notes. Debt-to-equity was 1.9x and total leverage was 3.6x, compared with 2.3x and 3.7x, respectively, at December 31, 2021. Common book value per share declined to $18.28 from $19.37, including a $1.66-per-share impact from the CECL allowance.
- Liquidity and cash flow: Cash and equivalents were $183.3 million, down from $271.5 million at year-end. Reported cash, cash equivalents and restricted cash decreased $83.1 million over nine months; operating cash flow was $104.0 million, investing cash outflow was $970.6 million and financing cash inflow was $783.5 million. Management reported $916.2 million of cash and available borrowings, plus $369.5 million of unencumbered senior loans available to finance subject to lender approval. KREF was in compliance with its debt covenants.
- Dividends and capital: Common dividends remained $0.43 per share for each quarter of 2022. KREF issued common and preferred equity during the first nine months and repurchased $28.3 million of common stock. Series A preferred stock carries a 6.50% annual dividend.
Material changes and management commentary
- Q3 net interest income increased sequentially by $1.4 million as floating benchmark rates and average loan balances rose. Interest expense also increased, by $22.6 million from Q2, reflecting higher rates and financing balances.
- The sharp Q3 credit provision reflected increased macroeconomic uncertainty, inflation, higher short-term rates and office-sector volatility and reduced liquidity. Management said the increase was primarily attributable to risk-rated 4 and 5 office loans.
- The loan portfolio totaled $7.61 billion in exposure across 76 loans; 99.9% of held-for-investment loan principal was floating-rate. Multifamily represented 45.4% and office 24.2% of collateral property types. KREF collected all interest payments due during the first nine months.
- KREF’s sole real estate-owned asset is a Portland retail property acquired through foreclosure; its net carrying value was $79.7 million. Q3 REO operations recorded a $0.5 million loss.
Outlook, risks and contingencies
- The filing provides no specific earnings, portfolio-growth or dividend guidance. Management said available liquidity should meet anticipated financing, operating and other needs under current conditions.
- Management cautioned that further rate increases could raise financing costs, affect real estate values, reduce loan prepayments and prompt more borrower extensions. KREF stated that rising rates generally benefit net income, but the result depends on the rate environment, portfolio and rate floors. Its sensitivity analysis estimated that a 50-basis-point rate decrease would reduce expected 12-month cash flows by about $7.4 million; increases of 50 and 100 basis points would raise them by about $7.4 million and $14.8 million, respectively.
- Key risks include office-market weakness, borrower refinancing and property performance, collateral-value declines, financing availability and potential credit-mark-to-market margin calls. Higher borrower extensions could outlast certain financing terms. LIBOR-based contracts also require transition to replacement rates; KREF warned that the change could increase borrowing costs.
- Future loan-funding commitments were $1.65 billion, generally subject to specified draw conditions. The $143.8 million convertible notes mature in May 2023. Contractual debt maturities include substantial amounts in 2023 and 2024; extensions may be available on certain facilities.
- Subsequent to quarter-end, KREF entered a $125 million asset-specific financing facility, repurchased $7.4 million of common stock, and paid the declared $0.43-per-share Q3 dividend. The filing reported no material legal proceedings and no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How the $114.9 million total credit allowance compares with updated property valuations, borrower plans and realized loan losses—especially for the three risk-rated 5 office loans and the Philadelphia office loan past its current maturity.
- Whether Q3 Distributable Earnings of $0.50 per share can be sustained after excluding the temporary benefit of unrealized credit-loss provisions from that non-GAAP measure, and how it compares with cash available for dividends.
- Near-term refinancing and extension outcomes for debt and convertible notes maturing in 2023, including the Morgan Stanley repurchase facility’s stated December 2022 maturity and the May 2023 convertible-note maturity.
- Capacity to fund $1.65 billion of commitments while preserving liquidity, meeting covenants and managing potential margin requirements or reduced financing advance rates.
- Whether rising rates, office demand, collateral values and the LIBOR-to-SOFR transition develop in line with assumptions underlying reported loan yields, fair values and loss reserves.