Q3 2020 KKR Real Estate Finance Trust Inc Earnings Call
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Good morning, and welcome to the K K, our real estate Finance Inc. third quarter 2020 financial results Conference call.
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Please note. This event is being recorded I would now like to turn the conference over to Michael Shapiro. Please go ahead.
Thank you welcome to the K T. Our real estate Finance Trust earnings call for the third quarter Twentytwenty, We hope that all of you and your families are continuing to take C and healthy.
Today I am joined on the phone by are CEO, Matt Salem, Our president and COO, Patrick Madsen, and our CFO stopped me God.
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 people.
Before I turn the call over to Matt I'll provide a brief recap of our results.
For the third quarter, we had a record GAAP net income of 31.4 million or 56 cents per share, which included 8.1 million benefit from a lower diesel provision.
Core earnings this quarter were 32.5 million or 58 cents per share driven by the continued strong performance of our portfolio and the significantly in the money LIBOR floors.
One change to note.
As per S.P.C. guidance, beginning with our fourth quarter results in early twenties 21, we will begin reporting core earnings inclusive of the change in Cecil Cecil provision.
Consequently, we'll recast prior quarter's results reflect the change in presentation.
Please note that had we adopted the aforementioned change in presentation core earnings per share. This quarter would have benefited by one penny and been 59 cents per share.
Book value per share as of September Thirtyth 2020 increase to 18, 73, which included the impact of $1.16 per share from C.. So as compared to 18 57 as of June Thirtyth.
Finally, I would note that in mid October we paid a cash dividend of 43 cents per share with respect to the third quarter.
With that I would now like to turn the call over to Matt.
Thank you Michael.
Good morning, and thank you for joining us today.
We hope you are all healthy and safe.
We had a strong quarter on many fronts.
We continue to see the benefits of.
Of our Companys conservative positioning.
On both our lending strategy.
And liability management.
Well <unk> has allowed us to differentiate ourselves during this volatile market.
Since the onset of coated.
Yep.
And a best in class portfolio.
A prize of $5 billion of lighter transitional.
Loading rate senior loans.
With the significant overweight to multifamily and office properties and.
And only 8% exposed to hospitality and retail.
Increased our market leading.
Fully non mark to market financing to 78%.
In order to further de risk our liability side.
Increased our liquidity position.
The inaugural issuance of about 300 million dollar term loan b.
Which enabled us to take advantage of the current lender friendly markets.
All while delivering record quarterly earnings.
Which has benefited from net interest margin expansion.
Resulting from our strategic we negotiated in the money LIBOR floors.
As of September Thirtyth.
Our portfolio balance was approximately 5 billion.
With only 462 million or 9% of total commitments.
For future funding obligations.
Our almost exclusive senior loan portfolio.
Focus is on institutional real estate and sponsorship.
And the secured predominately by class a lighter transitional multifamily and office properties and the most liquid real estate markets.
Our average loan size of 135 million.
And approximately 80% of our loans are secured by properties located in the top 10 markets in the United States.
Our investment portfolio is 99% senior loans with no direct holdings of Securities.
As I mentioned, our two largest property type exposures, our multifamily and office.
Which represent 83% of the portfolio collectively.
And have a weighted average occupancy in the mid seventies.
In addition, 86% of our multifamily loans.
And 75% of our office loans are.
Secure by class eight parties.
Underlying kind of collections have been consistently high.
As a reminder, none of our office properties are located in New York, San Francisco or Los Angeles.
Markets, which have seen significant increases to co working tenants in recent years.
Over 99% of our collections our current through.
Through October.
You are robust quarterly asset review process.
We reevaluate every loan in the portfolio to sign an updated risk rating.
Our portfolio has a weighted average weighted average risk rating of 3.1.
On a five point scale.
Consistent with the weighted average risk rating at June Thirtyth.
84% of the Port Boy was risk rated three or better.
We feel confident about the performance of those on those properties.
We don't anticipate much transition and our ratings in the near term.
As we did in the second quarter.
We provided a detailed breakout of our watchlist loans in our supplemental presentation.
We feel good about our position.
In many of these properties.
And are seeing improving trends in a number of business plans.
However.
We haven't been completely UN impacted.
As we have previewed prior.
Portland retail property is most negative negatively exposed.
And it was downgraded from a four rating.
Two five rating this quarter.
Well this loan is current as of October.
We expect to be entering workout discussions, giving the pending maturity.
We believe we have adequately reserved against any potential impacts from this loan through the Cecil evaluation process.
Well the second straight quarter, we are beginning to see some signs of normalcy in the broader market both from an origination and repayment perspective.
Starting with repayments.
During the quarter.
We received approximately 274 million of repayments.
Including an approximately $30 million paydown from one of our New York condo inventory loans.
Subsequent to quarter end.
We received an additional 65 million of repayment.
It's always difficult to accurately accurately predict repayments.
And even more so in this market environment.
But as a reminder, we have several loans our portfolio near or at stabilization.
On the origination side.
Well, we didnt close any new loans prior to quarter end.
We did close three transactions in October.
With many lenders on the sidelines, we were seeing a favorable market dynamics there's.
Resulting in better credits.
And opportunities to create net interest margins.
And the mid to high one hundreds.
That's compared to low one hundreds earlier this year pre covet.
Let me spend a couple of minutes, providing incremental details on our recently closed deals.
All three are good examples of our return to market.
And continued focus on the same high quality real estate, we have an underwriting since our IPO.
Additionally, they highlight the benefits.
Reference to use for being part of a leading global alternative asset manager.
And a growing real estate platform.
As you May have noted.
Hey, rough coordinated these transactions with other KKR private strategies.
Correct.
Flagship transitional senior loan strategy.
It has probably order priority over these investments.
But at times, where it makes sense.
He will share risk dependent.
Depending on factors such as the timing of commitment.
The loan size.
And congrats liquidity position.
The first two examples.
Similar to the loans were making pre cobot.
Refinancing newly delivered.
Luxury class a multifamily buildings.
In markets with strong underlying demographics.
Our loan provides our sponsors a better cost of capital and time to lease the property and burn off the initial lease up concessions.
Both properties have commenced leasing.
And there were no moving pieces as it relates to construction.
We were able to underwrite.
Recently signed leases.
And extrapolate into a stabilized cash flow.
We didn't do a straight board underwriting on a simple business plan.
And her notable transaction.
Hey, Rob co originated $509 million whole loans.
With tariff committing 160 million to leading real estate development company.
San Francisco Bay area to acquire and renovate a 1 million square foot.
Class a office in Oakland, California.
We're executing a senior loan sale of approximately 135 million.
The finance our retained 25 million dollar piece.
This financing is a great example of the benefits of having access to a broader asset management platform.
Utilizing the full pick your brain to lend on high quality.
Well located real estate.
The best examples of this are from a sourcing perspective.
Institutional sponsor.
That was an existing JV operator for our real estate equity team.
From an underwriting perspective.
Effectively single tenant assets.
But our corporate credit team.
It was already familiar with and an underwritten.
And we had local market knowledge.
We'll take our real estate owns office properties.
Finally.
Execution perspective.
We worked closely with our capital markets team.
I speak for the whole 509 million.
Well, having line of sight on the sale of the senior portion.
Generate an attractive return.
Our forward pipeline remains strong and.
Several loans under exclusivity.
Which are expected to close within the next few months.
You will continue to see us focused on investing in defense of property types.
In liquid markets.
And with top tier sponsors.
Well, Mike while maintaining our focus on capital preservation.
Sitting within the broader kick our platform.
It's a unique perspective.
And I'll look into risk adjusted returns across asset classes.
The combination of pay reps in place portfolio.
Our cost of liabilities.
And the addition.
The additional new loans underwritten in today's environment.
We believe our delivering attractive risk adjusted returns.
Relative to other yield proxies.
We are excited about our franchise.
In our competitive our competitive positioning in the market.
And the continued growth opportunities for CAE route for the remainder of 2020.
And going into 2021.
Now, let me turn the call over to Patrick.
Thank you Matt.
Good morning, everyone I.
I hope that you continue to stay safe and healthy.
As of quarter end, a market, leading 78% of our in place asset financing was completely non mark to market.
And the 22% remaining balance was only subject to credit marks.
We continue to invest a considerable amount of time and resources across KKR.
Differentiate and diversify our financing sources.
And in September we were excited to close or inaugural term loan b issuance.
The proceeds from the $300 million seven year, low and allow us to take advantage of the current lending opportunity.
As well as continue to reduce some of our more to credit facilities.
Additionally, the pricing flexibility of the term loan b affords us the ability to adjust the cost of capital in the future.
Batch the conservatively positioned profile of our assets and other liabilities.
Our intense focus on non mark to market financing has allowed us to lower the risk of our liabilities.
At the same time maintain target leverage levels. Despite the volatility this year.
As of quarter end.
Our debt to equity ratio and total leverage ratio were 1.9 times and 3.8 times respectively down.
Down from the second quarter.
As a reminder.
We have generally targeted a three to four times leverage ratio when new senior loans, depending on the source of financing.
Well, we've been willing to finance loans at a low eightys advance rate on our non mark to market financings.
We would expect our total leverage ratio to gravitate more toward the mid threes in the coming quarters.
Our repo financing.
Which currently represents only 22% of our outstanding secured financing.
It's diversified across three banks.
And currently has a weighted average advance rate well approximately 65%.
The repo facilities finance 10 loans.
Dominantly secured by class, a multifamily and office assets.
Notably we have not received any margin calls on these mark to credit facilities.
Okay reps liquidity position remains very strong with over 700 million of availability.
Including cash of approximately 300 million as of three Q.
And access to an additional 335 billion, where our corporate revolver.
While we have currently earmarked some of our liquidity for our increasing pipeline of blown opportunities.
Given the level of uncertainty in the markets, we do expect to hold incremental cash on the balance sheet versus prior years to maintain flexibility for the foreseeable future.
Which could create some incremental drag on earnings.
Additionally.
As we started to see the third quarter, a higher rate of repayments and timing mismatch between repayments and new originations.
Add to our liquidity position in the near term.
Finally.
Almost the entirety of the portfolio remains invested in LIBOR based floating rate loans.
90% of the loan portfolio has a LIBOR floor of at least 95 basis points.
Well only 2% of our liabilities, excluding the new term loan b heavily.
I have a LIBOR floor above zero.
So with spot Livewatch, averaging 16 basis points from the third quarter.
Our rate floors were almost entirely optimized for the full quarter.
Providing a significant earnings benefit.
We're further context on the benefit.
Since the beginning of 2021.
One month LIBOR has decreased to 160 basis points.
During this same period.
Bolstered by our rate floors or loan coupon to only decreased 20 basis points.
From 5% to 4.8%.
At the same time the decrease in LIBOR has dramatically reduced our liability cost.
Resulting in an expansion.
Of our effective net interest margin by 130 basis points.
To a level above 100 to a level above 280 basis points, one our direct secured borrowings.
As we experience a rotation in our portfolio through loan repayments and new originations.
We expect the NIM to compress overtime.
In summary.
Our best in class investment portfolio is providing strong earnings power through loan performance insignificant in the money rate floors.
We generated record net income during the quarter.
We continue to diversify our financing sources, including growing our market, leading 78% non mark to market secured liabilities with the issuance of the new seven year term loan b.
We have a very strong liquidity position allow.
Allowing us to return to the new originations market.
Lending at attractive levels on credits consistent with our historic underwriting.
Thank you again for joining us this morning.
And now.
We are happy to take your questions.
We will now begin the question and answer session.
I ask a question you May press Star then one on your Touchtone phone if.
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To withdraw your question. Please press Star then too.
At this time, we will pause momentarily to assemble our roster.
The first question today comes from Jade Rahmani of KBW. Please go ahead.
Okay. Thanks, very much can you give us some color as to the types of deals you're seeing and you know what the sponsors are looking to achieve you know if there's been any changes in the way their underwriting deals I noticed one of the deals had below 50% LTV just some color on the transaction market.
Hey, Jade its Matt Thanks for thanks for joining and good to hear you.
Yeah, I was a little bit of color.
We're seeing.
The market's slowly reboot here.
And obviously, we're starting to take advantage of that I would say all in coupons are and.
4% to 4.5% range.
Oh for the higher quality assets and.
There's there's real bifurcation I would say in the market today between the have and the have nots. So clearly you can understand <unk> hotels and other sectors that have been the most impacted you know the.
The financing there is much more difficult and no coupons much much wider there where we're focused is where we've been focus historically, so I don't think weve really changed.
Our credit DNA at all.
So.
Really trying to focus on the multifamily sector of the market and then well leased office.
What's a little bit different now is two things one so it's a it's more lenders market as you would expect so you get better structure better credit.
In some cases lower leverage obviously, the all in coupon similar to what we were lending at pre coated but the compositions changed quite dramatically given where <unk> libraries. So the spread is it's very high and the overall NIM.
As we mentioned on the call is an increase from low one hundreds to to very high 100.
The other thing I'd say is that the the fact pattern or the business plan that your lending on is a little bit more advanced.
And so for instance, if we were making a multifamily loan pre coded on a construction take out a lease up.
That property may have been somewhere between 10, and 30% occupied so some of the opportunities we're seeing today or more.
50% occupied or higher and clearly there's going to be a range but.
What the sponsors either just more time right everyone's trying to buy time, and so I think that.
The traditional segment of the market will continue to have a lot of opportunities to lend.
As sponsors just need to you know they need it to their their business plans are all elongating, whether that's you know any type of lease up and so they're just going to need to you know to by that time and getting new financing that then allows them to effectuate that business plan.
Tenant to the office sector are you seeing any broader changes in the way either sponsors lenders or the market. Overall is looking at office space. You know I think that pretty covered the average office lease with somewhere in the eight and a half to 10 year range and there is some chatter about yes typical lease duration.
And being curtailed JLL CEO said that in the second quarter. The average lease deal had 16% shorter term how are you thinking about that or what are you seeing with respect to the office market.
Yeah.
I think everyone puts office in this category of a it has a big question Mark around it you had.
On my mind.
It was a real cyclical issue with off that's I mean, you never want to lease up office in in an economic downturn.
And then there's the secular question that we're all debating around you.
Usage going forward.
Changes in behavior.
So I would say were given those.
Our both at play both the.
I know that you know the secular and cyclical I think we're very cautious right now on the sector. Overall, we don't have enough data points to answer your question directly or.
Or at least is getting shorter I would say as we're underwriting new office loans, we won.
The higher occupancy longer leases more stability and were still taking a lenders view in protecting our downside so.
I don't think the market's evolved enough to really.
Yeah, It's a really tell you what this is exactly what we're seeing in terms of shorter lease terms. It certainly wouldn't surprise me, but again I'm not sure that's a secular issue or or cyclical issue.
Okay, I'm turning to the Portland asset and you said that you feel adequately reserved.
With respect to your basis and the seasonal reserves yeah. What are you looking at the outcome in a work out is this going to be a essentially a foreclosure whereby K Ras takes control of this asset and figures out a repositioning strategy.
Would you bring in third party capital for this and just directly you know what impact will this have on the Companys liquidity is I believe this asset is not financed on any repo line. So it probably will have a minimal impact on liquidity, but if you could just touch on that.
Sure <unk>.
It's too early to tell on that you know.
How exactly the workout proceeds yeah, we have a sponsor in place still that's kept our loan current.
And so we'll be working with them on on what the business plan is going forward and.
Yes, I think it's too early to speculate how this may how this may play out.
Patrick I'll turn it over to you for the liquidity.
Perspective, but you know overall, it's not a it's not a big position, obviously for us and we have as much liquidity as we've had in the company, but Patrick you want to give any specifics.
Sure Jay just a follow up on that so we've got a small amount of leverage against this something on the order of less than 20% of the face amount of the loan so I'm not a not a big mover in terms of our liquid the usage. If we if we decide to pay off that financing.
Thanks very much.
Next question comes from John and Keith.
Thank God.
[noise] hi, good morning, So look I mean, it's good to see you guys holding grown in a difficult market I was wondering about if you could just provide us an update on some of the other watch list assets in particular, the New York Condos and then the Fort Lauderdale hotels.
Hey, John its Patrick let me start with that one so just first on the on the New York a condo hotel this.
This is an asset that you know over the last quarter in the last couple of quarters, we've actually seen an increase in sales. So both in the second and the third quarter, we saw all three.
Three unit sell in each of those quarters and there's an additional unit that have sold and closed I'm here in the fourth quarter, which will get reflected.
When we report next quarter.
I think we've been pleased with the progress of the pay down no sales for context had been in the $2200 a foot range.
Range and for context, our loan is around 17, 20, a square foot and.
So from a basis standpoint, we feel good we like that we like that we like the velocity.
You know again, so when those sales.
And the amount of leverage that we had you know similar to our Lloyd asset.
There's really a fraction of our outstanding loan balance. So in total we've had about a $41 million a pay downs you know these last two quarters.
On the asset in Florida, we continue to work closely with the sponsor as you recall. This is an asset where we have entered into a partial forbearance on the payments in exchange for some cash that came in from from the sponsor that parcel forbearance period.
Extends for several more months and we've seen some improvements in terms of the occupancy that asset, but it remains challenged.
In terms of.
The pre called mid level. So one that we continue to sort of monitor, but one where we've got a.
A path to continue to work with the sponsor and help them really sort of managed through this situation.
Got it and how would you describe the overall commercial real estate.
Lending markets from a stressed perspective I know, there's a lot of concern could you just talk about it from a high level.
Sure Dan it's not I can jump in there.
I guess a couple of things one it's I think it's lagging the more liquid markets.
Until then certainly we haven't seen anywhere near the level of.
Yield compression that you see in the corporate credit market or the securitized markets <unk>.
There's clearly a lag in the in the private markets are specifically in CRB lending.
There's a bifurcation like I'd mentioned before between.
The having the have nots right and that's really by property type for the most part to some extent business plan and the transitional limit then the second segment, but predominantly a prop.
Property type.
And so there's definitely a whole swath of retail assets and hotel asset that just.
Just don't have access to financing today or it's extremely expensive.
And then as it relates to to the business plans.
As you can imagine the more transitional you get the heavier the lift is it's got to be tougher to think that's right now and again that's a you.
You know we're in Oh.
Impressive market and I think people are cautious right now and so.
You can understand that.
The conservatism on the lending front with those assets.
And then I would just say in terms of the participants in the market you know what we're seeing at least in our spaces.
It was definitely less competition, which is making it attractive to them. Perhaps you know why were lagging here, but there, but there's capital out there I wouldn't call the market distressed and we are lending at 4% to 4.5% coupons I think thats attractive, but I don't think its distressed.
And you do see a number of participants in the market as you would expect the securitized lenders are back that you will see a b S product both on large loans as well as on on conduit insurance companies are very active I would say one of the sectors, where we haven't seen much activity or the big money Center banks.
And so that's one area that we're watching watching closely.
Thank you.
Thanks.
Next question comes from Stephen Laws of Raymond James. Please go ahead.
Hi, good morning.
I guess first wanted to ask about the ltvs on the the new originations I noticed two were refinances. So you would have done a new valuation analysis in October.
Can you talk about how much the value declined on those two appraised value declined on those two assets from the loan they were refinancing, which I would as a and then I assume that that that valuation was done pre cobot and.
Please let me know if that's not the case.
Yeah. Thanks for the question I don't think I have the exact answer in terms of like the appraisals lined up from there you know pretty constant to what we're doing today.
I will tell you on the multifamily assets.
Well, we're generally on a lease up multi family assets were generally generally underwriting down call it 10% to 15% area and value.
Just because it's taking longer to lease up and there's clearly a concession package involved in todays market. Since it's really the cash flows that are changing the valuation as you would expect and this kind of interest rate and market. We do we are we are seeing and we expect to see more cap rate compression once the.
The assets have stabilized, but it's taking longer to get there and our underwriting.
Okay and.
Okay, and then shifting over to the change in core in that and then coupled with that as an outlook on the dividend.
Kind of.
Believe Cecil the noncash item the Cecil reserves, so we'd love kinda, so a little more background on your thoughts to to now include that Oh see noncash diesel change and the core metric you know, especially with some of the inputs that go into that being macro and not company specific a dish.
Finally, you know I think historically, we've used core earnings as a proxy for the dividend, but I don't believe that Cecil is saw something that impacts re taxable income, which determines the dividend distribution. So can you talk about going forward. After this change what we should look at that as a proxy should we simply take your core earnings.
And Backout Cecil the way, it's been dine in and to that point any spillover income from last year and the income you can still forward a that we need to think about with regards to log satisfying to the 90% distribution requirement for this year.
Good morning, Steven Thanks for the question is on stop loss I'll take that one.
Yeah. So.
Just to clarify that a bit but season buckle earnings presentation, respectively.
But when I see calmed me see but any thoughts to no longer exclude revision all credit losses.
Or a portion of the provision for credit losses from our core earnings presentation going forward.
We then we don't it doesn't hold in Ginnie and also as noted by Michael in his prepared remarks.
So what it has meant that she just talking with Q4 and all subsequent be 14 tedious.
And I'll give you four for consistency, we will became our core earnings presentation for the first three quarters to respond within your presentation.
That said, we don't believe that Didnt change that does a seed in the presentation of core earnings for reporting purposes, and obviously that sees the provision will continue to be for single line item on our income statements.
So you know ER.
Anybody can do the math there with respect to the coverage from a dividend standpoint I think.
The old keynote presentation of core earnings would would would would be a good proxy and.
And we believe that we will meet the distribution requirements from from a dividend standpoint, there for this year.
Great I appreciate the time today and the comments thank you.
Thank you.
Our next question comes from Charlie Era of JP Morgan. Please go ahead.
Hey, good morning, guys. Thanks for taking the questions I'm a bit of a follow up on on the C. Sold there look I think there's there's no better demonstration I'm kind of a more incrementally positive economic outlook than putting money back to work.
In that context, it should we see it.
Tweaking of that seasonal reserve going forward and just how are you guys thinking about the overall reserve rate on the portfolio.
Yes, there's a little soft, but again so long I think good question, we'll just stick to the batteries are.
I think obviously that varies fluctuate quarter over quarter, depending on a variety of factors, including obviously, our originations volume our restatements velocity and all the changes to the macro Oh Buffalo bad.
But generally speaking it everything else equal.
We would expect you know the biggest driver would that change in the Pizza reserve would be.
Dilution of any of them on the watch list loans before a flight between loans and also the natural the macro outlook over the next few quarters.
So this will be the two key drivers.
Okay got it thank you and then.
Just the unrelated follow up I know there was some.
Deferred interest discussions on I think the Portland loan, but I'm just wondering if there were any other additional loan modifications that what kind of executed during the quarter.
Hi, Charlie Good morning, it's Patrick.
So in terms of the corridor, we obviously had the two hotel loans, where we had modifications in place. There was one other modification related to interest payments, which is on the New York.
Condo loan, which I talked about earlier and there we entered into a partial forbearance when a portion of the of the interest payments now there was a little bit of pay downs associated with that but that's it in terms of.
Interest related modifications in the quarter.
Great. Thanks, so much for taking the questions guys.
Thank you.
This concludes our question and answer session I would like to turn the conference back over to Michael its appeal for any closing remarks.
Thank you everybody for joining us today, we hope you stay safe stay healthy and if there's any follow up questions. Please feel free to reach out to any of us. Thank you again.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.