KKR Real Estate Finance Trust Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 20, 2019. KREF is an externally managed commercial real estate finance REIT focused primarily on originating and acquiring senior loans. Unless otherwise indicated, financial figures are for the year ended or as of December 31, 2018; dollar amounts are in U.S. dollars.
Business context and portfolio
KREF reported a rapidly expanded portfolio of commercial real estate loans and CMBS B-pieces. The portfolio was reported at $4.13 billion; loan exposure was $4.09 billion across 41 loans. Management said the portfolio was 100% performing, with no impairments, past-due loans, or loans rated impaired/loss likely. Senior loans had a weighted-average loan-to-value ratio of 68%. Approximately 99% of loan exposure was floating-rate; 98% of investments by total assets earned floating-rate interest. All investments were in the United States.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Interest income | $183.6 million | $83.1 million |
| Interest expense | $85.0 million | $21.2 million |
| Net interest income | $98.6 million | $61.9 million |
| Total net revenue | $118.7 million | $79.6 million |
| Net income attributable to common stockholders | $87.3 million | $58.8 million |
| Basic and diluted EPS | $1.58 | $1.30 |
| Net Core Earnings (non-GAAP) | $105.9 million; $1.92 per diluted share | $55.5 million; $1.22 per diluted share |
| Dividends declared per common share | $1.69 | $1.62 |
| Book value per common share | $19.66 | $19.73 |
Net interest income rose 59%, primarily as the weighted-average loan balance grew by $1.6 billion. Net income attributable to common stockholders increased 48%; EPS rose 22%, reflecting both higher earnings and a larger weighted-average share count. Operating expenses increased 57% to $28.9 million, including $4.8 million of incentive compensation to the Manager. The year’s $13.0 million realized gain on CMBS sales contributed to reported results; Net Core Earnings excludes certain items and is not a GAAP measure.
Fourth-quarter 2018 net income attributable to common stockholders was $19.7 million, or $0.34 per share; quarterly net interest income was $27.4 million. The fourth-quarter dividend was $0.43 per share.
Cash from operating activities was $76.8 million, investing cash outflow was $2.00 billion, and financing cash inflow was $1.90 billion. Cash and cash equivalents ended the year at $86.5 million. Reported available liquidity, including cash and available borrowing capacity, was $284.3 million.
Balance-sheet commercial mortgage loans held for investment were $4.00 billion. Secured financing agreements were $1.95 billion, CLO liabilities net of issuance costs were $800.3 million, convertible notes net were $137.7 million, and loan-participation liabilities were $85.5 million. Total portfolio financing, including off-balance-sheet/non-consolidated senior interests and participations, was $2.93 billion. Total leverage was 2.6x, up from 1.0x; the company’s narrower debt-to-equity measure was 1.1x, up from 0.8x. Consolidated balance-sheet total assets were $5.23 billion, including consolidated CMBS trust assets and corresponding liabilities; selected financial data also presents total assets net of VIE liabilities.
Material changes versus 2017
- Portfolio value nearly doubled, and KREF originated 19 floating-rate senior loans with $2.7 billion of commitments; $2.4 billion was funded by year-end.
- Financing expanded and diversified: KREF issued an $810 million CLO, established a $1.0 billion non-recourse term-loan facility, added $200 million of asset-based financing capacity, expanded repurchase capacity, and replaced its $75 million revolver with a $100 million unsecured revolver.
- Non-mark-to-market financing reached approximately $1.8 billion, representing 60% of portfolio financing by outstanding principal, reducing—but not eliminating—exposure to market-value-driven margin demands.
- In April 2018, KREF sold its controlling interest in four of five CMBS trusts for $112.7 million net proceeds and recorded a $13.0 million gain. The remaining CMBS investment had a $2.6 million unrealized loss during 2018.
- KREF issued $143.8 million of 6.125% convertible notes due May 2023, completed public offerings including 5.5 million primary shares, and repurchased 1.62 million shares for approximately $31.3 million.
Outlook, risks and unusual items
No quantified earnings or portfolio guidance is provided. Management expects future activity to remain weighted toward floating-rate senior-loan originations, funded through repurchase facilities, asset-based and term financing, and CLOs. Management stated that rising short-term rates generally benefit earnings, but cautioned that asset yields and funding costs may adjust at different speeds. A 50-basis-point rate increase or decrease was estimated to change annual cash flows by approximately $4.4 million in either direction, based on the year-end portfolio and assumptions disclosed.
- Credit and real estate risk: Property operating weakness, falling collateral values, borrower defaults, concentration, and losses on subordinate investments could impair returns. While management reported no impaired loans, 33 of 41 loans were rated “average risk” and eight “low risk” under its internal scale.
- Leverage, funding and liquidity: Repurchase facilities can require additional collateral or repayment following collateral-specific value deterioration; refinancing, facility renewals, and access to capital markets are not assured. Contractual obligations and commitments totaled $5.16 billion, including $419.5 million of future loan funding commitments; this amount includes obligations not all payable as recourse corporate debt.
- Interest-rate benchmark transition: LIBOR-linked assets and liabilities may be affected by the planned cessation of LIBOR submissions after 2021 and the transition to replacement benchmarks.
- Management and governance: KKR controls the company and allocates investment opportunities among KREF and affiliated vehicles. The filing describes conflicts of interest, affiliate fees and financing arrangements, and the cost and difficulty of terminating the management agreement.
- REIT and regulatory requirements: Failure to maintain REIT status or the Investment Company Act exclusion could materially affect taxes, operations, and distributions. The company also disclosed adoption of the expected-credit-loss standard was expected to increase and accelerate loan-loss provisions; it had no loan-loss provision recorded at year-end.
- Unusual accounting/equity item: A $1.9 million non-cash redemption-value adjustment on redeemable special non-voting preferred stock reduced earnings attributable to common stockholders and book value per share. No material legal proceedings were reported.
Subsequent to year-end, KREF originated a $76 million loan, funded $28.4 million of previously closed loans, received approximately $297.8 million in loan repayments, paid the fourth-quarter dividend of $0.43 per share, and repurchased 212,809 shares for $4.1 million.
Important facts for investors to verify
- Reconcile GAAP net income of $87.3 million with non-GAAP Net Core Earnings of $105.9 million, including the CMBS sale gain, unrealized items, Manager incentive compensation, and preferred-stock adjustment.
- Review the composition and maturity of the $2.93 billion of total portfolio financing, recourse exposure, covenant headroom, and collateral/margin-call terms; assess the $419.5 million of unfunded loan commitments against available liquidity.
- Examine loan-level concentration, internal risk-rating trends, collateral performance, and the basis for the reported 68% weighted-average LTV and 100% performing status.
- Assess dividend coverage and sustainability against taxable income, GAAP earnings, operating cash flow, funding needs, and debt covenants; the filing states distributions are discretionary and establishes no minimum.
- Evaluate KKR control, affiliate fees and transactions, allocation of investment opportunities, and the management agreement’s termination provisions.
- Confirm the status of LIBOR replacement planning and the expected impact and implementation timing of the expected-credit-loss accounting standard.