KKR Real Estate Finance Trust Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. KREF is an externally managed 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 stated otherwise.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Interest income | $62.9 | $40.4 | $127.7 | $72.1 |
| Interest expense | $37.1 | $18.8 | $71.9 | $29.5 |
| Net interest income | $25.9 | $21.6 | $55.8 | $42.6 |
| Net income attributable to common stockholders | $17.4 | $23.5 | $42.1 | $46.8 |
| Diluted EPS | $0.30 | $0.44 | $0.73 | $0.88 |
| Common dividends declared per share | $0.43 | $0.43 | $0.86 | $0.83 |
- Portfolio and assets: Total assets were $6.18 billion, up from $5.23 billion at year-end 2018. Held-for-investment commercial mortgage loans, net, were $4.80 billion, versus $4.00 billion. The portfolio comprised 36 loans with $4.91 billion total loan exposure; 99.9% of loan exposure was floating-rate.
- Credit and returns: The weighted-average loan risk rating was 2.8 (average risk); all loans were rated 3 or better, with none rated high-risk or impaired. No loans were past due or on nonaccrual at quarter-end. Management reported Q2 Core Earnings of $21.6 million ($0.38 per diluted share) and Net Core Earnings of $20.5 million ($0.36 per diluted share). These are non-GAAP measures and are not substitutes for GAAP results.
- Cash flow: For the first half, operating cash flow was $40.2 million, investing cash flow was negative $822.9 million, and financing cash flow was positive $878.9 million. Cash and cash equivalents rose $96.2 million to $182.7 million; this balance included $42.0 million held in the CLO.
- Debt and liquidity: Balance-sheet carrying values included $2.89 billion of secured financing agreements, $801.9 million of CLO debt, and $138.4 million of convertible notes. The company also reported $958.7 million outstanding under its non-recourse term loan financing. Debt-to-equity was 1.7x and total leverage was 3.4x, compared with 1.1x and 2.6x at December 31, 2018. Reported cash and available borrowing capacity totaled $483.7 million, including a $250 million undrawn revolver. KREF reported compliance with its financing covenants.
- Book value: Book value per common share was $19.54, down from $19.66 at year-end 2018. Stockholders’ equity was $1.12 billion.
Material changes versus comparable periods
- Q2 net interest income rose 19.9% year over year as the loan portfolio expanded, but interest expense rose 97.3% alongside higher borrowings and LIBOR. First-half net interest income increased 31.0%.
- GAAP common-stockholder income and diluted EPS declined year over year. A $13.0 million realized gain on CMBS B-Piece sales benefited Q2 and first-half 2018, with no comparable gain in 2019. In 2019, KREF also recorded a $2.2 million Q2 unrealized loss on CMBS B-Pieces.
- Operating expenses increased 46.7% in Q2, including $1.1 million of incentive compensation to the Manager, versus none in Q2 2018. First-half expenses increased 29.6%.
- The loan portfolio grew, while its weighted-average coupon declined to 5.7% from 6.0% at year-end 2018. Management attributed earnings growth in net interest income primarily to portfolio expansion and higher LIBOR, partly offset by increased financing costs.
Outlook, risks, contingencies, and unusual items
- No specific earnings or dividend guidance was provided. Management expects future investment activity to remain focused mainly on floating-rate senior loans and expects to distribute 100% of net taxable income for the foreseeable future, while retaining capital for business needs.
- Management reported that 73% of portfolio financing, by outstanding principal, was non-mark-to-market. Repurchase facilities remain exposed to collateral revaluation and potential margin calls; some facilities may mature before the loans pledged as collateral. Financing costs and availability may also change.
- Interest-rate sensitivity analysis estimated that a 50-basis-point increase in short-term rates would increase 2019 cash flows by approximately $5.0 million; a 50-basis-point decrease would increase them by approximately $1.9 million. These estimates reflect the portfolio and financing position at June 30, 2019.
- Credit and property risks include borrower defaults, weaker collateral values and commercial real estate market deterioration. Two underlying loans representing 1.05% of one CMBS pool were delinquent and in foreclosure; a newly delinquent underlying loan contributed primarily to the Q2 CMBS valuation loss.
- KREF had $532.6 million of future loan-funding commitments, primarily for construction, capital improvements, tenant improvements and leasing costs, generally subject to borrower and project conditions. It also had a remaining $4.1 million commitment to RECOP.
- KREF stated that adoption of the expected-credit-loss standard in Q1 2020 is expected to increase provisions for potential loan losses and recognize them earlier in the credit cycle. No provision for loan losses was recorded at June 30, 2019.
- No material legal proceedings were reported, and the filing stated there were no material changes to previously disclosed principal risk factors. Forward-looking statements remain subject to economic, interest-rate, credit, real estate, financing, regulatory and other risks.
- Subsequent events included a July office-loan origination with a maximum face amount of $170 million, approximately $32 million of funding on previously closed loans, $4.4 million of loan paydowns, and $98.1 million of net additional secured borrowing. KREF paid the declared $0.43-per-share Q2 dividend in July.
Important facts for investors to verify
- Whether portfolio growth and higher floating-rate income can continue to outpace rising interest and funding costs, particularly if rates or credit spreads change.
- The quality and performance of the expanding loan book, including the status of delinquent loans in the CMBS pool and the assumptions underlying Level 3 valuations.
- Liquidity available after considering $532.6 million of loan commitments, dividend requirements, debt maturities, and potential collateral margin calls.
- The implications of increased leverage, financing counterparty exposure, and the use and terms of non-mark-to-market and non-recourse financing.
- How GAAP earnings compare with Core Earnings and Net Core Earnings, including Manager incentive compensation, and whether dividends remain supported by taxable income and cash generation.