KKR Real Estate Finance Trust Inc. (KREF) — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. KREF is an externally managed mortgage REIT focused primarily on originating and acquiring commercial real estate loans, principally floating-rate senior loans.
Financial performance and position
| Metric | Q3 2020 | Nine months 2020 |
|---|---|---|
| Interest income | $67.7 million | $206.0 million |
| Interest expense | $28.8 million | $98.5 million |
| Net interest income | $38.9 million, up 35.7% year over year | $107.5 million, up 27.4% |
| Net income attributable to common stockholders | $31.4 million; $0.56 per diluted share | $24.8 million; $0.44 per diluted share |
| Common dividend declared per share | $0.43 | $1.29 |
| Operating cash flow | Not presented for the quarter | $91.4 million, versus $68.2 million in 2019 |
For the nine-month period, net income fell from $65.7 million to $24.8 million, primarily reflecting the new credit-loss provision and lower other income. Q3 earnings improved year over year as lower interest expense more than offset lower interest income. The filing does not present a conventional net profit margin measure.
At September 30, total assets were $5.23 billion, including $4.83 billion of net commercial mortgage loans and $301.4 million of cash. Stockholders’ equity was $1.04 billion; book value was $18.73 per share, down from $19.52 at December 31, 2019. Recorded debt and loan-participation liabilities included $2.85 billion of secured financing, $808.3 million of CLO debt, $287.9 million of secured term debt, $140.1 million of convertible notes and $66.2 million of loan participations sold. The reported debt-to-equity ratio was 1.9x and total leverage ratio 3.8x, versus 3.5x at year-end 2019.
Reported liquidity sources totaled $700.6 million: cash, available facility capacity and $42.0 million of loan repayments held by the servicer and receivable by the CLO. This includes $335.0 million available under the corporate revolver. Operating, investing and financing cash flows for the nine months were $91.4 million, $4.1 million and $138.2 million, respectively.
Material changes and portfolio condition
- KREF adopted CECL on January 1, 2020, recording a $15.0 million opening retained-earnings adjustment. It recorded $53.8 million of net credit-loss provision expense for the first nine months; the loan allowance was $62.7 million at quarter-end, with another $1.4 million reserve for unfunded commitments.
- Book value per share included an estimated $1.16-per-share CECL allowance impact and a $0.08-per-share write-off on a $5.5 million mezzanine loan. The loan write-off was $4.7 million.
- The portfolio comprised 37 loans with $4.92 billion principal exposure. Management reported 99.9% performing and collected 99.8% of Q3 interest payments due. Average risk rating was 3.1, compared with 2.9 at December 2019; 13.7% of exposure was rated high risk and 2.3% impaired/loss likely.
- Three modified loans, totaling $319.3 million principal, included temporary partial payment-in-kind interest provisions; $2.4 million of PIK interest was added to principal year to date. Management said the modifications were not troubled debt restructurings under GAAP.
- In September, KREF raised $300 million in a secured term loan, issued at 97.5% of principal, with a 2027 maturity and a floating rate of one-month LIBOR plus 4.75%. The company also repurchased 2.04 million shares for $25.0 million during the first nine months; no shares were repurchased in Q3.
Outlook, risks and contingencies
Management gave no specific earnings or portfolio-growth guidance. It warned that COVID-19 could continue to materially weaken borrowers, tenants, property cash flows, real estate values, results and liquidity through the rest of 2020 and potentially longer. Hospitality and retail were identified as particularly affected, though the loan portfolio was concentrated in multifamily (51.8%) and office (30.5%). Borrower requests for deferrals or other modifications, defaults, foreclosures and principal losses remain possible. The company expected to distribute at least 90% of 2020 REIT taxable income, while stating that it would continue to assess capital and liquidity needs; the Q3 common dividend of $0.43 per share was paid in October.
Funding commitments on commercial loans were $462.3 million. Management reported compliance with financing covenants at quarter-end and no margin calls to date, but repurchase facilities can require additional collateral or repayment if specific collateral values deteriorate. The new secured term loan’s minimum-net-worth and leverage covenants begin applying in Q1 2021. Nearly all loans and financing arrangements are LIBOR-linked, creating transition risk as LIBOR is expected to be discontinued after 2021. No material legal proceedings were reported. Management concluded disclosure controls were effective.
Subsequent to quarter-end, KREF reported $201.2 million of initial funding on three new loans, $14.4 million of additional funding on existing loans, and $64.7 million of loan repayments.
Important facts for investors to verify
- How the CECL allowance and changing risk ratings evolve, particularly for loans rated 4 or 5 and COVID-affected collateral.
- Whether reported collections, portfolio performance and borrower modifications remain stable, and whether any deferred PIK interest is ultimately collected.
- Liquidity available after meeting $462.3 million of loan commitments, dividends, debt maturities and potential collateral calls; distinguish usable corporate liquidity from CLO-restricted cash and proceeds.
- Debt leverage, facility renewal and covenant headroom, including the new term loan covenants effective in 2021 and the LIBOR transition provisions.
- Whether the $0.43 quarterly dividend remains supportable as COVID-19 effects and taxable income develop; the filing provides no assurance of future dividend levels.