KKR Real Estate Finance Trust Inc. (KREF) — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Unaudited results. KREF is an externally managed mortgage REIT focused primarily on transitional commercial real estate loans.
Financial performance and position
| Metric | Q2 2022 / June 30, 2022 | Comparable period / prior date |
|---|---|---|
| Interest income | $90.6 million | $67.1 million in Q2 2021 |
| Interest expense | $44.7 million | $27.0 million in Q2 2021 |
| Net interest income | $45.9 million | $40.2 million in Q2 2021 |
| Net income attributable to KREF | $25.1 million | $31.1 million in Q2 2021 |
| Net income attributable to common stockholders | $19.4 million; basic and diluted EPS $0.28 | $29.3 million; basic EPS $0.53 and diluted EPS $0.52 in Q2 2021 |
| Common dividend declared | $0.43 per share | $0.43 per share in Q2 2021 |
| Distributable Earnings (non-GAAP) | $33.1 million; $0.48 per diluted share | Q1 2022: $29.8 million; $0.47 per share |
| Total assets / permanent equity | $7.71 billion / $1.68 billion | $6.70 billion / $1.36 billion at Dec. 31, 2021 |
| Commercial real estate loans, net of allowance | $7.44 billion; allowance $31.5 million | $6.29 billion; allowance $22.2 million at Dec. 31, 2021 |
| Cash and cash equivalents | $118.0 million | $271.5 million at Dec. 31, 2021 |
For the six months ended June 30, 2022, operating cash flow was $68.4 million, investing cash flow was negative $1.14 billion, and financing cash flow was positive $927.6 million. Cash, cash equivalents and restricted cash declined $148.1 million to $125.7 million.
Balance-sheet debt included $3.57 billion of secured financing, $1.93 billion of CLO obligations, a $337.6 million secured term loan and $142.5 million of convertible notes, net. Reported debt-to-equity and total leverage ratios were 1.9x and 3.5x, respectively. Primary liquidity sources totaled $790.3 million, including $118.0 million cash and $610.0 million available under the corporate revolver; KREF also reported $416.0 million of unencumbered senior loans available to finance, subject to lender approval. KREF said it was in compliance with financing covenants.
Material changes and portfolio
- Compared with Q2 2021, net interest income rose 14%, but common-stockholder net income fell 34.9% and EPS declined from $0.53 to $0.28. Higher interest income reflected portfolio growth and rising benchmark rates; higher financing costs and a $11.8 million quarterly credit-loss provision weighed on earnings.
- For the first half, net interest income increased 11.7% year over year, while common-stockholder net income declined 15.8% and EPS fell from $1.05 to $0.75. The credit-loss provision was $10.6 million, versus a $2.1 million reversal in the prior-year period.
- The loan portfolio grew to 77 loans with $7.53 billion outstanding principal. All loans were floating-rate; weighted-average LTV was 67%, and 96% of exposure was rated risk category 3 or better. Average risk rating was 3.0, compared with 2.9 at year-end 2021. Multifamily and office represented 48.6% and 23.2% of loan principal, respectively.
- KREF reported the portfolio as 100% performing and collected all interest payments due during the first half. Separately, one $5.5 million mezzanine loan was on nonaccrual and fully written off; the portfolio performance statistic excludes this written-off loan.
- Funding activity expanded: KREF issued a $847.5 million CLO in February, increased its revolver capacity to $610 million, and entered a $350 million term lending facility. Common and preferred stock offerings generated $340.1 million net proceeds in the first half. KREF repurchased 1.04 million common shares for $18.1 million during Q2.
Outlook, risks and unusual items
No specific earnings or dividend guidance was provided. Management stated that available liquidity was expected to meet anticipated short- and long-term financing, operating and other requirements under current conditions. It continued to expect investment activity to focus largely on floating-rate senior loans.
- Management attributed the higher credit-loss allowance to macroeconomic uncertainty, increased reserves on watch-list loans and portfolio growth. The allowance, including unfunded commitments, totaled $34.3 million at quarter-end.
- Inflation and Federal Reserve rate increases could raise funding costs by more than asset income, slow borrower prepayments, increase loan extensions and affect collateral values. A 50-basis-point decrease in index rates was estimated to reduce next-12-month cash flows by $3.4 million; increases of 50 and 100 basis points were estimated to add $5.4 million and $12.8 million, respectively.
- LIBOR transition remains a risk: 73.7% of loan principal and 64.0% of floating-rate financing were LIBOR-indexed at quarter-end. KREF warned that replacement benchmarks could increase borrowing costs.
- Future loan funding commitments were $1.41 billion, primarily for construction, property improvements and leasing costs. Contractual obligations also include significant debt maturities, with $456.9 million scheduled in 2022 and $1.20 billion in 2023; facility extensions may be available subject to conditions.
- KREF’s sole real estate-owned asset was a Portland retail property acquired through foreclosure. It reported $79.2 million net carrying value and Q2 REO operating expenses of $2.4 million. Q2 other income also included a $0.9 million nonrecurring local tax and energy credit; prior-quarter other income included $1.3 million of loan-payoff profit sharing.
- Management cited continuing COVID-19, supply-chain and labor disruptions, geopolitical uncertainty, real estate market weakness, borrower defaults, financing availability and potential repo collateral calls as risks. No material legal proceedings or material changes to previously disclosed risk factors were reported. Disclosure controls were deemed effective.
Key facts for investors to verify
- Whether the rising CECL allowance and risk-rating migration translate into realized loan losses or further reserve increases.
- Coverage of the $0.43 quarterly common dividend by recurring Distributable Earnings, which was $0.48 per share in Q2; Distributable Earnings is a non-GAAP measure.
- Liquidity and refinancing capacity against near-term debt maturities, repo collateral requirements and $1.41 billion of unfunded loan commitments.
- Net interest income sensitivity as benchmark rates rise and financing and loan benchmarks transition from LIBOR to SOFR or other alternatives.
- Valuation, redevelopment progress and cash flows from the Portland retail REO, and the collectability and timing of loan repayments and extensions.