KKR Real Estate Finance Trust Inc (KREF) 2022 Q4 法說會逐字稿

Good morning, and welcome to the KKR Real Estate Finance Trust Inc. Fourth Quarter 2022 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Jack Switala. Please go ahead.

Great. Thanks, operator, and welcome to the KKR Real Estate Finance Trust Earnings Call for the Fourth Quarter of 2022. As the operator mentioned, this is Jack Switala. Today, I'm joined on the call by our CEO, Matt Salem; our President and COO, Patrick Mattson; and our CFO, Kendra Decious.

I would like to remind everyone that we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in our earnings release and in the supplementary presentation, both of which are available on the Investor Relations portion of our website. This call will also contain certain forward-looking statements, which do not guarantee future events or performance. Please refer to our most recently filed 10-K for cautionary factors related to these statements.

Before I turn the call over to Matt, I'll provide a brief recap of our results. For the fourth quarter of 2022, we reported GAAP net income of $14.6 million or $0.21 per diluted share, including a CECL provision of $21.2 million or $0.31 per diluted share. Distributable earnings this quarter were $12.4 million or $0.18 per share, including a write-off of $25 million or $0.36 per share. Distributable earnings prior to realized losses were $0.54 per share relative to our Q4 $0.43 per share dividend, driven largely by the higher rate environment.

Book value per share as of December 31, 2022, was $18, a decline of 1.5% quarter-over-quarter. Our CECL allowance decreased to $1.61 per share from $1.66 per share last quarter. Finally, in early December, we paid a cash dividend of $0.43 per common share with respect to the fourth quarter. Based on yesterday's closing price, the dividend reflects an annualized yield of 10.9%.

With that, I would now like to turn the call over to Matt.

Good morning, and thank you for joining us today. Before turning to the current market and company results, I'd like to reflect on KREF's achievements during 2022. Despite a very challenging environment, we made significant progress enhancing our liquidity and diversifying our already best-in-class non-mark-to-market liabilities. In 2022, we optimized and diversified our financing sources, and as a result, sit on record levels of liquidity. Last year, we added $2.5 billion of non-mark-to-market liabilities. Notably, we increased the borrowing capacity on KREF's corporate revolver by $275 million to $610 million and extended the maturity date through March 2027. This revolver is a key contributor to our nearly $1 billion in liquidity as of year-end.

77% of our secured financing as of year-end was completely non-mark-to-market and the remaining 23% is only marked to credit. In addition, we have $1.9 billion of CRE CLO liabilities that are price of attractive spreads and still in their reinvestment periods. In 2022, we grew our permanent equity base by 15% to $1.6 billion. We raised approximately $150 million of preferred equity at a 6.5% fixed for life coupon. We completed 2 public offerings of common stock, resulting in net primary proceeds of $188 million. KKR reached its target long-term hold position of 10 million shares, representing 14% of our shares outstanding, resulting in market-leading alignment between KKR and KREF.

Equally as important was our disciplined approach to buying back shares when KREF traded below book value. At 2022, we repurchased 2.1 million shares for nearly $36 million. Since our May 2017 IPO, KREF's repurchased nearly $100 million of stock. I cannot overstate the impact of our partnership with our manager, KKR, and the strength of our real estate platform. KKR's integrated real estate business provides us with a robust view of the current operating environment, which has become more dynamic over the past few quarters as the Federal Reserve has embarked on a virtually unprecedented pace of interest rate increases.

This broader real estate platform collectively manages over $64 billion of AUM and has grown by approximately 60% since the end of 2021. For example, KKR's real estate private equity team owns or manages over 90 million square feet of industrial assets and over 30,000 multifamily units globally. We were able to draw on real-time data and market intelligence from this property portfolio, which informs our investment decisions as a lender.

The KKR Real Estate Credit business is substantial in its own right with $30 billion of assets under management and a dedicated team of 66 at year-end 2022, with 9 senior investors responsible for over $10 billion in originations. As a reminder, KREF is KKR's flagship, senior transitional CRE lending strategy and hold the first priority position within the allocation waterfall. This team originated $2.7 billion on behalf of KREF in 2022 across 25 loans, concentrated our efforts in the growth property types with nearly 70% secured by multifamily and industrial properties and another 22% secured by life science properties, our focus on lending to institutional sponsors on high-quality real estate and growth sectors and markets has positioned us well to navigate the current environment.

Our largest property type is multifamily, which represents approximately 45% of the overall portfolio. We continue to see strong performance across that segment with median same-store rental rates up 12% in the portfolio for fourth quarter of 2021 to the first fourth quarter of 2022.

That said, and as we discussed last quarter, the office sector remains challenged with little liquidity across both debt and equity. Our underweight in office will benefit KREF on a relative basis. We are diligently working through our watch list office loans. Our first preference is to work with our existing sponsors. However, many properties will require additional capital and sponsors will need to demonstrate commitment to the asset with additional equity. We are not in the free option business, and our mindset is to deal with any issues now and not to kick the can down the road with a sponsor who was not economically incentivized to lease at current market rates.

Fortunately, we have many tools at our disposal to optimize these outcomes, including taking title and operating assets until liquidity returns. We are also in a position to be proactive with our borrowers and work towards faster resolutions because we have high levels of liquidity at the corporate level.

Turning to earnings. The high interest rate environment continues to be a tailwind for our distributable earnings. In 2023, we expect the portfolio to turn over modestly, and we will continue to match originations with repayments. We expect repayments for 2023 to be approximately $1 billion weighted to the back half of the year. As we navigate this new year, we are very well positioned with a strong portfolio, best-in-class liabilities and record levels of liquidity.

Lastly, I want to take a moment to thank Todd Fisher who resigned from the KREF Board of Directors earlier this month to accept a position with the United States Department of Commerce. Mr. Fisher has been an integral part of our team since KREF inception, and we thank him for his thoughtful guidance and steering the company. We wish him well in his future endeavors.

With that, I'll turn the call over to Patrick.

Thank you, Matt. Good morning, everyone. I'll focus today on our efforts on the capital and liquidity front and provide an update around our CECL reserve and watchlist loans. In 2022, with the continued help of our partners in KKR Capital Markets, we added $2.5 billion in non-mark-to-market financing. In the public capital markets, we closed a $1 billion managed multifamily CLO earlier in the year, providing KREF with $848 million of non-mark-to-market and nonrecourse financing in a 2-year reinvestment period.

In the private markets, we closed on a term lending agreement, totaling $350 million, with an option to increase the facility to $500 million and entered into 3 new asset-specific financing facilities totaling nearly $500 million. We also increased the borrowing capacity of an existing $500 million term lending agreement to $1 billion. Finally, we increased our corporate revolver by $275 million to $610 million and extended the maturity date through March 2027.

Of the $2.5 billion in total capacity added this year, 2/3 is truly bespoke liabilities. The resiliency of our financing structure, coupled with our independence from the public capital markets is a true differentiator and buffers KREF on the liability side during times of capital markets volatility. KREF is well capitalized today and continuing to preserve flexibility in today's market environment. Our debt-to-equity ratio was 2x, and our total leverage ratio was 3.8x as of quarter end. Our approach to managing the balance sheet allows us to start 2023 with a record level of liquidity in excess of $950 million, including our $610 million undrawn corporate revolver and $240 million of cash.

Additionally, at quarter end, KREF had $180 million in unencumbered senior loans on the balance sheet. We're maintaining our defensive posture with a focus on managing liquidity. This quarter, we recorded a $4 million net decrease in our CECL reserve of $115 million to $111 million or 147 basis points based on the funded loan portfolio. Similar to our commentary in Q3, nearly half of our total CECL reserve remains held within our 5 rated loans. Additionally, as we noted last quarter, the CECL reserve is unrealized and noncash. We will recognize a loss through our cash metric of distributable earnings if such amounts are deemed nonrecoverable, as we did this quarter.

Turning to the watch list. In December, we finalized the plan to modify a $161 million senior office loan, previously risk rated of 4 located in Philadelphia. As part of the modification, KREF agreed to subordinate $25 million of our senior loan in the form of a junior mezzanine loan in return for a $25 million principal repayment from the sponsor. The principal repayment is structured as a new senior mezzanine loan and reduces KREF's mortgage exposure to $111 million. At year-end, the loan was risk rated a 5; however, following the execution of the modification in January, the new senior loan was upgraded to a risk rating of 3.

In addition to the $25 million pay down, the sponsor committed to fund an additional $16.5 million for future capital expenditures and leasing costs, which will bring the total senior mezzanine loan balance to $41.5 million fully funded. The subordinated hope note is structured as a junior mezzanine loan and does have a priority of cash flow once the senior mortgage and senior mezzanine loans are fully repaid with interest. KREF wrote off $25 million of the loan balance in Q4.

Regarding our other 2 risk rated 5 loans, there are sponsor-led sale processes in progress, and we are maintaining an active dialogue with these sponsors. For the Minneapolis loan, we executed a short-term extension to facilitate this sale process. And for the other Philadelphia loan, we have an initial maturity date in May of this year.

With regard to the broader portfolio, 88% of our loan portfolio remains risk rated 3 and we collected 100% of scheduled interest payments across the portfolio in Q4 and through the first payment date in 2023.

A few final comments. KREF finished 2022 strong with a $7.9 billion total funded portfolio, representing a 17% year-over-year increase. We originated 3 senior loans in Q4 for a total of $370 million and sourced and closed $125 million asset-specific financing. Finally, we repurchased approximately 500,000 shares of common stock in Q4 at a weighted average price per share of $16.41 for a total of over $7.4 million. Over the last 3 quarters, we've been opportunistic in utilizing our share repurchase program with 2.1 million shares repurchased in 2022 for a total of $36 million. Additionally, this month, the Board reauthorized $100 million buyback program.

Thank you for joining us today. And now we're happy to take your questions.

And our first question will come from Don Fandetti of Wells Fargo.

Obviously, office continues to be a pressure point. Can you talk a little bit on how your borrowers are handling the higher rate environment? Are you making modifications? And just talk a little bit about your expectations. I would assume that there'll be more reserve building on your office portfolio as we go forward through '23.

Sure, Don. It's Matt. Thank you for the question today. I appreciate you joining the call. I'd say specifically -- let's start at the interest rate environment right now, certainly putting a lot of pressure on the overall system. However, our borrowers do have interest rate caps in place. And so they're not fully exposed to current SOFR or current LIBOR, if we haven't converted it over yet.

And then clearly, as those interest rate caps expire, typically at the initial maturity date of the loan, they are required to re-up those interest rate caps and buy a new one. And that's really when the conversations take place around potential modifications on the loan. It's another opportunity for us to take a look at the credit and understand where we are and add any other structural features that we want.

And we've been working with our sponsors in terms of giving them some flexibility on their interest rate caps. So for instance, if our interest rate cap requires a 2-year term, requires a very low strike accommodating them to either a shorter duration or a little bit higher strike and return for typically cash reserves that we would hold for future interest rate cap purchases, et cetera. So we want to work with them and help alleviate definitely pressure points as it relates to that, but it's typically a return for some type of other consideration within the loan document.

As it relates to further buildup on office in terms of our reserves, we go through the portfolio every quarter. And where we stand now, we feel comfortable with the reserves. It is a very robust process. I think our eyes are wide open. You've seen us being very transparent and pretty front-footed as it relates to not only increasing reserves, but as you saw this quarter, modifying loans and trying to get to the other side and create the right basis for us and for sponsors so that they can lease in what's a difficult operating market for office. So feel comfortable right now with where we stand on the reserves, and we'll just have to you'll see what the future brings in terms of how we're positioned elsewhere.

The next question comes from Rick Shane of JPMorgan.

Thanks, I appreciate you taking my questions this morning. Look, one of the few places where GAAP and tax diverge is related to realized losses. So to the extent, you did realize a GAAP loss of $25 million. I'm curious if you believe that it's met the threshold from an IRS or tax perspective as well? And then if you could talk specifically about -- because it occurred in the fourth quarter, but perhaps the tax loss might be realized in 2023? How we should think about the timing and how that falls.

Sure. Thank you, Rick. Appreciate you joining, and I appreciate the question. The -- you asked about the write-off that we incurred in Q4 and that $25 million write-off will be a taxable event in the year the modification closed, which was 2023. Maybe pulling the thread on this a little bit. The sum of our quarterly dividends paid in 2022, plus borrowing part of the dividend that was paid in January 2023. And this throwback dividend concept is a practice that's allowed under the REIT rules and that we've used in the past means that we are fully distributed for 2022. And so there is no special dividend that would be required.

Got it. And no excise tax or anything that we need to think about in that regard.

Right. That's right. We met all of those thresholds. That's correct.

The next question comes from Stephen Laws of Raymond James.

Patrick, I guess I'll start with -- I point this to you since you mentioned it in your comments, but I think half the reserves are related to the 5 rated loans. As we think about that and kind of pair it with Matt's comments that going to focus on resolutions quickly and not kick the can down the road, how do we think about those moving from specific losses and to realized losses and running through distributable earnings over the course of this year?

Stephen, thanks for the question. So if you look at our reserves, as we said, about half of the 5 rated loans or about half the reserves are attributed to the 5-rated loans. If you look at the asset where we had the write-down in the fourth quarter, we realized a write-down of about 16% against that balance. And coincidentally, the reserve that's held against those 5 rate loans is pretty close to that -- pretty close to that number.

We're obviously working through each of these loans individually. All of the 4s and 5s that are on there are going to have potentially different levels of loss content. Not every 4-rated loan is a loan where we think there's a high degree of loss. Some of the 4-rated loans are on there as a reflection of the fact that we think there's a near-term catalyst or a near-term event that may lead to a modification. So hopefully, that addresses what you were asking.

Yes. I guess, kind of to take half of the one -- we were on $111 million, so if you're looking at $55 million, will we see all of that run through a loss, assuming your reserve where you at the appropriate level for the assets resolved or monetized? Like just trying to think about the timing of when that's going to hit. Is that this year or early next year? Kind of how do we think about the timing of those monetization or realizations?.

Yes, sure. I think the timing is difficult to forecast here. Clearly, with those 5 rated loans that we talked about, there's processes in place to get to some form of liquidation event. So not unreasonable to think that we could see some realization over the course of this year. I think the bigger question probably is just related to the quantum there. We feel good about where we're reserved, but clearly, in this market, the realized amount could come in greater or less than what we've set aside.

And moving to the financing side on these loans. Can you talk about how the watchlist loans are financed and if that is financing exposed to credit marks, how those discussions are going with counterparties as you work through these watchlist loans?

Sure. There's a little bit of a disconnect between necessarily what's on a watchlist and the loan -- whether the loan is performing, as we've indicated, we collected 100% of our interest payments through last year and the first payment date of this year. So the real driver, especially on these non-mark-to-market facilities is the loan current. And in fact, all of these loans are current. So there isn't really much concern in the immediate term as it relates to those loans.

Obviously, as we get to maturity dates or we need further modifications or restructuring, that's when we're going to have more in-depth conversation with our lenders. I would say those conversations have been constructive to date as we've worked through some of the loans. The asset that we had a write-off in the fourth quarter that was not on a financing facility that was unlevered. But sort of post now the modification of that loan, that loan is a loan that we can finance on any number of facilities. So -- but I would say the conversations have been constructive, and we have an opportunity to kind of work through and get runway where needed.

The next question comes from Jade Rahmani of KBW.

I wanted to ask, in terms of your quarterly interest income, do you know what percentage of that is funded out of interest reserves that are structured upfront as part of the loans?

Jade, it's Matt. I can jump in there. I don't have that number right in front of me right now. It's not abnormal obviously, for us to have reserves or recourse obligations to guarantees to fund interest payments, just given the nature of the business plan and lease-up, et cetera, but don't have the exact number in front of me.

Okay. But is that an issue in terms of any shortfall in performance and pressure from elevated interest rates, the exhausting of those reserves in coming quarters?

I mean, listen, it comes back down to value at the end of the day. So if you look at most of our portfolio is in these growth sectors and value there has held up well and the fundamentals are really strong. So I kind of put this in the same bucket as interest rate cap discussions as those expire. There's a lot of value behind these loans and the sponsors re-up and come out of pocket and buy the next interest rate cap.

So lots of times, our reserves are set to accommodate for interest at the cap, et cetera. But to the extent they're not, I wouldn't expect a lot of pressure there. I would just expect the sponsors to re-up on the reserve.

On the multifamily credit outlook, it was somewhat surprising to see the downgrade on the West Hollywood asset. I was wondering if you could talk to your overall expectations for that sector. It's definitely been a resilient sector in past cycles. However, the early '90s did see credit issues and CMBS throughout time, has always had credit issues in multifamily.

This time around, we do have a record level of units under construction disproportionately concentrated in the growth markets and then a lot of deals done at very low cap rates, which would have pressure from valuation as well as interest rate caps. So what would be your outlook in terms of multifamily credit performance?

Yes. I think we're still, I think, very favorable outlook on multifamily credit performance. Clearly, values have come down a little bit to -- and cap rates have increased just to accommodate the higher cost of capital in the current interest rate environment.

On the occupancy side, the properties -- or the market is still operating at basically all-time highs. And we're still seeing pretty favorable rent growth, although it's come down a fair amount as we reported just on this call, we've got about -- and just in our KREF portfolio, rents were up on a same-store sales basis, 12% year-over-year from fourth quarter of '22 to '21 -- or from '21 to '22, excuse me. So -- and I expect that to continue to come down. My guess is across a broader set of assets that's probably in the high single digits today. By the way, which I still think is very, very healthy and is kind of the Fed is activity is obviously having some impact on that, which is probably a net positive for the whole market.

In terms of supply, agree, there is a wave coming out right now. And I think that will impact some of these local growth markets. But at the end of the day, all these markets are under-housed. And so it really is just a short-term phenomenon in terms of the market digesting those new units. And keep in mind, there's very little behind that. There hasn't been a lot of new construction financing available in the market over the course of the last 6 months or so and certainly not readily available today either. So you're going to have a little bit of a blip probably as the market goes through that and then it should be a pretty favorable setup after that with new supply really tapering off. So I would say, overall, still very constructive on that market and haven't really seen any material signs of deterioration there.

The next question comes from Eric Hagen of BTIG.

I'm curious how you think your appetite for risk, maybe changes as a result of raising your reserve. Like should one expect the parameters for your target assets to necessarily change. And is there a threshold for the reserve where it does begin to change your risk parameters more meaningfully?

Eric, you're speaking about the new loans that we're making in terms of how we're evaluating like the current market, et cetera?

Yes, exactly. Yes.

Well, yes, let's start there. Number one, it's a very lender-friendly market right now. You've got a large participants completely on the sidelines. Commercial banks are still not actively lending in the market. Loan to values have come down a fair amount. Obviously, the V in that equation is down with the current interest rate market. So we like the market right now. We think it's very attractive.

And you could see what we did last year, the vast majority of our lending activity was in multifamily and industrial sectors, which we still believe in the fundamental backdrop there, as I just described with Jade. So I don't think that really like what we're looking at, like reserves or things like that are really impacting how we're thinking about making a new loan or what we would focus on.

Some of it does come back to liquidity. And we are, as you saw in our report at pretty high levels of liquidity right now. And I think that's more of a function of just the market uncertainty. And the volatility that we're seeing in the market and is making sure that we've got plenty of excess liquidity to deal with any issues that may come up.

And I think it's a little bit less about reserves, but one of the reasons why we've been so front-footed and trying to work out some of these loans, and you saw the modification we did this past quarter. Once we get through this, there should be a pretty good opportunity to lend on the other side of that. So probably less about reserves and more about just watching the liquidity and working through a couple of these loans that we got the 5 rated loans, and once we get through that I think that will really kind of change some of our posture in the market as it relates to take advantage of the current market opportunity.

Yes. Yes. That's really helpful. Maybe you can share some of the things that you're seeing from your seat at KKR more broadly about the flows of capital into commercial real estate. How much capital you see getting allocated to the sector this year? Maybe even how you see being the incremental buyer in the market with there being this layer of uncertainty that we're all talking about.

Sure. So stepping away from KREF for a second and just talking about what we're seeing broadly in capital flows. I would say that start in the real estate credit side, there is a pretty consensus view, a strong view really globally that credit is very attractive today. And within that segment, real estate credit is very attractive. And so while a lot of allocators in the market are experiencing a denominator effect, just given where the equity market is the -- so the overall pie might be shrinking.

You want to think about the component of that pie being real estate credit is growing. So we're taking market share, if you will. And we're certainly seeing that on the fundraising side with more allocators favoring real estate credit. So that feels like a good opportunity. And on the real estate equity side, I think the market is very much looking at values and trying to understand, okay, where values stay, thinking about their own portfolio. But at the same time, the opportunistic funds, I think we'll have success raising capital.

First of all, there's ample dry powder available today across the market, almost record levels of dry powder to invest in real estate. And the fundamental setup in many of these property types and markets is still pretty good. So I think you'll continue to see capital being raised on the opportunistic side of the market, as well on the equity side. So overall, everyone is dealing again with a little bit of headwinds from the denominator effect, but still seeing very good flows across the real estate spectrum.

The next question is a follow-up from Jade Rahmani of KBW.

You mentioned $1 billion of repayments this year. Do you know the dollar amount of loans scheduled for initial maturity that will have to meet some kind of extension tests? And I know you talked about you're not giving away anything for free. So it sounds like you're going to be pretty strict in those discussions.

Yes, Jade, I can talk about it, and I'll turn it over to Patrick to give you the exact number. But a lot of the portfolio was originated post COVID. And so it is a smaller dollar amount, but we can give you the initial maturity here. And agree. I mean -- we want to work with our sponsors, we want to be reasonable. And however, all those initial maturities or most of those initial maturities have some form of test to get into extension periods. And those tests can be met in many cases. And in some cases, where they're not met, that's another opportunity to have a discussion and try to better our credit overall. So that's how we approach it.

And with that, I'll turn it over to Patrick who can add whatever -- any other comments he want and talk about the numbers.

Jade. Sure. Happy to elaborate here. So in the supplement, we show kind of our fully extended terms, and you can see that this year, about 6% of the portfolio is scheduled to have a final maturity date. In terms of like initial maturity date, inclusive of those numbers, that grows to about 21% of the total portfolio. So about $1.7 billion in total.

Thanks very much. The West Hollywood multifamily deal. Sorry, I didn't hear before, but did you provide any color on that deal? And if not, could you talk to just some overall statistics or give some sense of what characterizes it? I see that the average unit value is something like $2 million per unit. And if you make some cap rate assumptions, you're talking rents north of $15,000 a month. So any color you can give there, and why that deal was downgraded to risk rating 4?

Yes, sure. I can give a little bit of color there. And you're right in the sense that it's a very high-end luxury multifamily property is actually -- it was built for condo. So it is basically top of the market. And great location in West L.A., as you highlighted there.

And the reason we downgraded that was really around modification discussions that we were having around interest rate caps and just trying to get to -- make sure we got to a good place as those discussions were ongoing. And this, again, comes back a little bit back down to -- comes back to value. And so I think we feel pretty good about our basis and the overall value of that asset, but we just downgraded it as we went through modification discussions on interest rate caps.

I have one more. Are there any other questions in the queue because I just wanted to ask you that I've got some investor questions on this.

Sure, go ahead, Jade.

Just on the CMBS exposure, which is a joint venture. What's the risk of any write-down there? And I believe those positions are B pieces. So there would be special servicing rights. Is that really just a mark-to-model kind of calculation, what would drive any value degradation there that we could see?

Got it. Yes. So that's an investment in a fund that owns of 2017 and '18 vintage conduit B pieces. The marking process on that is same as pretty much everything we do at KKR. That's a third-party service provider that marks that. We don't mark that internally on a model or anything like that, that's a purely outsourced marketing service.

And obviously, the 2 main things that could impact that market are: number one, just risk premium increasing in the market; and the number two, fundamentals and defaults. What we've seen in our overall CMBS portfolio, I would say, again, keeping in mind, it's a tiny, tiny part of what's within KREF. So I was speaking more broadly about funds we manage outside of KREF is continued strong performance there, especially on the conduit side, where these borrowers have locked in 3.5% fixed interest rates for 10 years, the going in coverage was very high. Typically, over 2.5x to 3x coverage on those lower interest rates, and they'll enjoy that interest rate for quite some time. So another, call it, 7 years or so in some cases. So I think that we continue to see strong performance across that portfolio with really de minimis delinquencies.

This concludes our question-and-answer session. I would like to turn the conference back over to Jack Switala for any closing remarks.

Great. Thanks, operator. Thanks, everyone, for joining today. And please follow up with me or the team here if you have any questions. Take care.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.