Q1 2024 KKR Real Estate Finance Trust Inc Earnings Call

Participants

Jack Switala; IR Contact Officer; KKR Real Estate Finance Trust Inc

Matthew Salem; Chief Executive Officer, Director; KKR Real Estate Finance Trust Inc

W. Patrick Mattson; President, Chief Operating Officer; KKR Real Estate Finance Trust Inc

Rick Shane; Analyst; JPMorgan Chase & Co

Stephen Laws; Analyst; Raymond James & Associates, Inc.

Sarah Barcomb; Analyst; BTIG, LLC

Steve Delaney; Analyst; JMP Securities

Jade Rahmani; Analyst; Keefe, Bruyette, & Woods, Inc.

Don Fandetti; Analyst; Wells Fargo Securities

Presentation

Operator

Good morning, and welcome to the KKR Real Estate Finance Trust, Inc. First Quarter 2024 Results Conference Call. All participants will be in listen-only mode. (Operator Instructions)
Please note this event is being recorded. I would now like to turn the conference over to Jack Switala. Please go ahead.

Jack Switala

Great. Thanks, operator, and welcome to the KKR Real Estate Finance Trust earnings call for the first quarter of 2024. 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'd 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 Q 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 first quarter of 2024. We reported a GAAP net loss of $8.7 million or negative $0.13 per share. Distributable earnings this quarter were $26.7 million, or $0.39 per share book value per share as of March 31, 2024 was $15.18, a decline of approximately 2% quarter over quarter. Our CECL allowance increased to $3.54 per share from $3.6 per share last quarter. In mid-April, we paid a cash dividend of $0.25 per common share with respect to the first quarter.
With that, I'd now like to turn the call over to Matt.

Matthew Salem

Thank you, Jack. Good morning, everyone, and thank you for joining us today. I'd like to begin with a brief brief update on the state of the market. Despite the latest higher than expected CPI print resulting in muted expectations for near term interest rate cuts, the commercial real estate market continues to heal with increased transaction volume, price, transparency and liquidity across most property types, given narrowing views around interest rates and sustained economic growth, combined with valuation stability we are beginning to see encouraging green shoots.
The lending environment is competitive as the significant amount of capital availability outweighs suppressed transaction volumes. Over the last 24 months insurance companies foreign banks and government agencies have been able to meet the needs of the market in sympathy with broader macro strength.
Spreads are tightening with recent lending on stabilized real estate in the mid one hundreds with US banks still largely on the sidelines and the increased market activity. Our expectation is for this supply demand imbalance to normalize and potentially reverse creating an attractive opportunity for Keyera to fill this void as we resume lending in the next few quarters.
But our team has not been dormant given KKR's large and diversified CRE credit platform we have been actively originate loans throughout this cycle. Our bank insurance and debt funds pool of capital across the US and Europe are actively investing with a budget of approximately $10 billion this year.
Our own pipeline demonstrates this return of transaction volumes with an existing pipeline of deals in review or in closing of approximately $20 billion, totaling over 100 opportunities This compares favorably to last year's weekly average pipeline of $14 billion.
While we expect CRE lending across the US banking activity to remain muted, we are seeing a notable shift in preference from direct mortgage origination to loan on loan facilities to institutions like ourselves. This change is driven by more efficient capital treatment, less intense resources and relative safety in terms of property type fundamentals. The office sector remains challenged, though we are beginning to see more liquidity now than six months ago.
In PRS portfolio, we continue to feel we have identified the potential office issues within our watch list and do not anticipate further negative ratings migration to the watch list from the office sector. In terms of Life Science, we remain positive on the sector, given the long-term demand from innovations and science and technology, you though the market has seen a decrease in funding, we downgraded one additional life-science loan to our watch list this quarter as a result of challenges posed by the short term leasing slowdown.
Multifamily fundamentals have slowed given new supply dynamics, but liquidity in the sector is very high. Market research suggests a 50% decline in multifamily construction starts in 2024 versus 2022, leading many investors to look at the elevated rate environment and current rent pressures. Multifamily represents 43% of our portfolio and has performed well with weighted average rent increases of 3.4% year over year.
Now turning to KKR's earning results for the first quarter of 2024, clearly comfortably covered our $0.25 per share dividend this quarter with distributable earnings of $0.39 per share. As we stated last quarter, we set our dividend at a level that we can cover with distributable earnings ex losses. With our performing loan portfolio under a number of different scenarios. Our expectation is that in the near term, DEX losses will continue to be significantly higher.
Then our dividend with the help of KKR Capital Markets, Keyera continues to maintain high levels of liquidity was $620 million of availability at quarter end, including $107 million of cash on hand and $450 million of undrawn corporate revolver capacity. We have diversified financing sources across a number of facilities totaling $8.7 billion with $2.9 billion of undrawn capacity, 78% of our secured financing is completely non-mark-to-market with the remaining balance mark to credit only Paradyne's no corporate debt or final facility maturities until 2026.
Composition of KKR's financing structure remains a true differentiator. This quarter, we received $336 million in loan repayments, including full repayments of $173 million on our previously four rated DC office loan and $151 million on our previously four rated New York City condo loan.
We funded $103 million for loans closed in previous years for a net reduction of $232 million. Prepayments have now exceeded fundings in four of the last five quarters, and we expect this to continue with aggregated projected repayments throughout 2024 of over $1 billion.
Sara as an externally managed vehicle benefit from access to resources, relationships and expertise of KKR's global real estate platform that manages nearly $70 billion of assets across across both debt and equity.
Our dedicated team of approximately 150 real estate professionals has a strong reputation as a full-service capital solutions provider. This integration provides us with an optimal tool kit to implement a variety of strategies to maximize value across our portfolio.
In addition, CoStar, our affiliated rated special servicer with a team of more than 45 professionals and over $45 billion of special servicing rights representing over 5,000 properties, provides us with extensive access to an expert team with sizable real-time market information.
We will continue to proactively and transparently navigate this challenged real estate market. As we mentioned last quarter, we will patiently optimize our REO portfolio. And as we sell those assets, we believe we can reinvest the capital to generate an additional $0.12 per share and distributable earnings per quarter.
And with that, I'll turn the call over to Patrick.

W. Patrick Mattson

Thank you, Matt. Good morning, everyone. I'll begin with updates to our CECL allowance and watch list. CECL reserves increased $33 million this quarter, driven primarily by collateral dependent loan reserves, resulting in an aggregate $246 million of CECIL. This was largely related to a further downgrade of our $37.5 million retained mezzanine loan backed by an office property located in Boston.
As we mentioned last quarter, KREF is currently in modification discussions, and we anticipate subordination of a portion of our mezzanine loan to new equity contribution from the existing sponsor regarding our risk rated five, Seattle life sciences loan and Mountain View office loan.
We are working with those respective sponsors to take ownership through a deed in lieu of foreclosure in Q2 as we explore the path of joint venture partners and continue to evaluate the go-forward business plans. Further details on these loans as well as our existing REO portfolio is reflected on page 13 of our supplemental.
We experienced no realized losses in the first quarter of 2024. However, during the second quarter, as we anticipate taking title to the Mountain View and Seattle assets. We expect a significant portion of our collateral dependent loan reserve to flow through distributable earnings, coupled with the anticipated modification on our Boston office loan, we project realized losses to total approximately $140 million in Q2 or approximately $2 per share.
In line with our existing reserves across these three assets for FedEx for our Philadelphia assets that became REO last quarter, we have an agreement in place to sell two of the four buildings with a closing date tracking for Q2, we're comfortable holding the remaining office building and parking garage longer term.
However, we may have an opportunity to sell those properties as well. And we'll update everyone on the next call. Kref is well capitalized with a debt to equity ratio of 2.1 with look-through leverage ratio of 4.1 as of Q1, slightly lower than year end we expect deleveraging to continue through the remainder of 2024 as repayments are anticipated to outpace future funding obligations.
Cambrex weighted average risk rating on the portfolio remains 3.2% and 85% of our portfolio is risk-rated three or better. Keyera has built a fortified liability structure that is diversified across two CRE CLOs, a number of matched term lending agreements and asset-specific financing structures as well as our corporate revolver.
KREF substantial liquidity position of over $600 million at quarter end, including $450 million of undrawn revolver capacity is a key component of our ability to navigate this dynamic credit and interest rate environment, coupled with our best in class financing over 75% of which is fully non-mark-to-market and our long-standing relationships with our financing partners and borrowers. Keyera has the tools at its disposal to withstand the challenges of today's market environment.
Thank you. For joining us today. Now we're happy to take your questions.

Question and Answer Session

Operator

(Operator Instructions)
Rick Shane from JPMorgan.

Rick Shane

Hey, thanks for taking my question this morning. So when we look at the reserve rate at the end of the first quarter and we take the implied or the charge offs that you've guided to the second quarter, it would imply a reserve rate ex those on expected losses of about 140 basis points to 145 basis points on is does that seem appropriate?
It's obviously well below what your reserve rate has been in the last year or two, but it is also reflecting the realized loss on specifically reserved assets. How should we think about reserve rate as you start to realize some of the bigger losses that you've held.

W. Patrick Mattson

Good morning, Patrick. Thanks for that question. So I think in terms of that number, it's around 150 basis points and 160 basis points on the balance. So I think you're directionally correct there. I think what it is really reflective of is as we work through some of these more challenged assets on the watch list, we are going we're going to get down to a pool where we think we've got relatively from the clean composition. And so I don't I don't view that number as sort of high or low, it feels probably appropriate right now. I think longer term that could even feel a little bit high. But in this market that's probably the right level.

Matthew Salem

Yes. Look, you know that I love metaphors and I think that in some ways, the reserve is a piggy bank that you've been depositing in for many quarters. And I guess what you're saying is that we should expect it is now time to crack over open to take the bank and perhaps make some withdrawals.

W. Patrick Mattson

I think directionally that's what's happening when you think about the guidance that we're giving on the second quarter.

Rick Shane

To Patrick, I can get you to buy into my piggy bank metaphor.

W. Patrick Mattson

It wasn't bad.

Rick Shane

Thanks, guys.

Operator

Stephen Laws, Raymond James.

Stephen Laws

Good morning. I first want to start, I guess follow up on the reserve question, and I think you guys appreciate the color on the five rated loans. As you think about the four rated loans three of which are multifamily, how do you think about the next three to six months for those assets, what are the key things you're watching that may move them back to a three versus moving to a five.
And when you take a step back and look at the collateral values versus your attachment point with the loans, do you feel there's still good coverage there from a collateral standpoint or what is the risk that if they move to five, it will drive incremental specific your asset specifically here.

Matthew Salem

Stephen, it's Matt. I can jump in on that one I appreciate you joining the call and asking the question from you. I think on the four loans, I guess I would I would break it down a little bit as you're suggesting in terms of just by property type.
Think we still believe that the multifamily segment, while it's going to have new ways, especially as you think about just a little bit higher rate environment for a little bit longer, could put more pressure on some of the sponsors that don't have as much liquidity as others.
But we don't feel like there's material loss content in that component of the portfolio. I think we've stated that in previous earnings calls, I think we still feel like that today. So while certainly there's the ability to transition a multifamily property from a three to a four, four to five over time. You're really looking through to what's the what's the value of that asset versus our basis, I think we still feel So pretty good about the overall positioning there.
When you start to think about some of the other assets like life science or other things there's a little bit more jump risk, I think in terms of just okay, what happens as those transition through, of course, it's not ready to buy. These bonds are rated by for reason there performing paying current debt, et cetera. But at that moment, we're just starting to get into difficulty or your monetary default, then those reserves can certainly increase.

Stephen Laws

Appreciate the comments there. And then that I wanted to follow up on your comments around originations. I know you guys have had really been focused on asset management for the past year and you mentioned that maybe the supply demand balance is shifting possibly more in your favor over the next coming quarters.
What is it that you're kind of looking for before shifting back on offense as it is getting these three resolutions in the second quarter behind you? Is it something some segment of your existing portfolio that you want to monitor performance before returning to offense? Or is it really the returns available that that seem pretty tight on stabilized assets that you don't think is an attractive time to put money to work? Maybe maybe a little more clarity on what you're looking for to resume new originations?

Matthew Salem

Yes, Steve, I'm happy to jump in. I would say I think it's more internal to KRF right. What we're looking at on within our own portfolio than it than a comment on the market environment goes, as I mentioned, through our various pools of capital away from tariffs like we're actively lending. We like the market there. We just think it's going to get better over time.
And so what are we looking for within within KKR, I would say a couple of things, number one, just on consistent repayments. So we're starting to see that. Obviously, you want velocity in your portfolio before you start lending new new capital and I think that velocity is coming back. And then certainly four of the five last quarters, we've had repayments offset future fundings.
We think we'll get $1 billion of repayments this year. So that certainly that starting to move in the kind of green zone in terms of how we're looking at it. And the second thing would just be okay, portfolio migration in terms of like what are we seeing from a credit perspective that feels like it's slowing down now.
This isn't a market I particularly want to protect predict the future, but certainly when we look at the velocity of where things are going from three to fours and fours and fives, that wave of office feels like we've dealt with a lot of that already. And there's other things that have come in recently, but it feels like it's slowing down. So I think just some stability around that and the portfolio migration.
And then finally, just leverage ratios, right? Just make sure we get back to where we historically have operated, which has been in more of that high threes context versus very low fours where we are today and that's migrating in the right way.
And certainly, when we look through our projections, we expect that to continue to go in the right in the right direction. So those are probably the three things we're watching most closely. We are from a liquidity perspective, we have lots of liquidity. So certainly we can go out and make another loan or two. But I think we really want to see those other those other areas firm up before we are we move in that direction.

Stephen Laws

Great. Appreciate the comments this morning.

Operator

Sarah Barcomb, BTIG.

Sarah Barcomb

Hi, good morning, everyone. And my first question is related to the life science portfolio. Could you talk about the leasing outlook for assets that are still three rated that may be close to delivering the projects, but potentially remain vacant on? Could you give us any insight into lead into leasing for life science and your portfolio in general? Thank you.

Matthew Salem

Asserts search that you're happy to happy to answer that. As you identified it, we've got a couple to some life science loans on the watch list today, when you look at the loans on the properties outside of those, those two that have been identified about 70% of the remaining exposure there is newbuild, as you're suggesting.
So by definition, very, very high-quality trophy in some in some cases. And these are extremely well located assets in the best and the best life science markets in the country. So I think we feel very good about about where those stand currently. Some are kind of lease ready and some are still in the process of finishing construction and waiting for that moment to we really have an opportunity to attract a tenant in.
But I think what we've seen is that the velocity and it's early days. And but certainly with the allies and to some extent, some leases that are getting signed at these these assets, there's a little bit more velocity in these newer build a purpose-built assets and new construction than we've seen in maybe some of the conversion plays.

Sarah Barcomb

Okay, great. And then my follow-up question is related to the REO portfolio. Could you walk us through expectations for potential CapEx spend on these assets? And maybe some commentary on your expectations for foreclosures going forward beyond your expected REO disclosures?

Matthew Salem

I think from a cap It's about again, let me start on the on the CapEx side. I would say we're still finalizing these business plans. And as we go REO, we'll develop we'll develop those I guess when we think about it in a couple of ways, number one, we are we were perfectly, I think, committed to spending CapEx to positioning these assets in absolutely the best way possible to attract really high-quality tenants and to stabilize and stabilize the property.
So that is that is our mindset that we will spend money to create value. I would say, number two and in most cases from just a pure CapEx perspective, we don't think there's large large outlays. I think a lot of the a lot of the capital is going to come from good news from tenant improvement and leasing commissions as we as we sign as we sign tenants there.
And from a I guess, the two ways you could think about as like from an earnings perspective. And from a liquidity perspective, certainly from a group perspective, not worried about it all again, it's not a big number. We have we have ample liquidity to implement any strategy we wanted to.
And from an earnings perspective, a lot of the CapEx by definition is going to get capitalized and have the assets so it's not going to come through earnings, and we'll have a little bit of just expenses that will certainly impact earnings.
And when we thought about resetting the dividend, clearly that was kind of factored into some of the scenario analysis as we think about that. So hopefully, that helps address a little bit of your of your of your CapEx questions and then from an REO perspective or foreclosure perspective.
I think we've identified everything at this point in time in terms of where you what's in the watch list that we're kind of proceeding down that path. And of course, we'll keep that transparency on a quarterly basis and that change we can we can update it, but there's nothing kind of like lack right now that we're but we haven't identified that we plan to go to title on.

Sarah Barcomb

Great. Thank you.

Operator

Steve Delaney, JMP Securities.

Steve Delaney

Good morning, everyone.
Can you hear me?

W. Patrick Mattson

Good morning. Yes, we do very well.

Steve Delaney

Great. Thanks. On the cellphone this morning, listen, first, I really applaud the the forward disclosure about that the losses, the projected REO and the realized losses in the second quarter, it makes I think it'll make certainly make their life easier and it will yours.
And I think shareholders as well, just to kind of not have the uncertainty about 2Q. So I'm looking at page 11 now, given that perspective and should we think about this after those projected REOs fit as far as five ratings as you see things right now on that you're basically left with the Mini and Boston office properties. Is that the way to look at it sort of post the have the REO action?

Matthew Salem

That's right. Yes. I mean, obviously, absent any other changes, that's the way to think about it and keep in mind that Minneapolis we have modified that load that's gone through restructuring. And then as Patrick mentioned in his remarks, the Boston office is currently under modification discussions current currently, and we tried to reflect that in the the reserves for this quarter.

Steve Delaney

Got it. And with Boston, I'm a little unusual there because the [38 retained mez do shut out is the $38 million your exposure at KRAP. and the the difference between the total $188 million is with other KKR entities].
Is that the way to do that now there's a little bit of nuance there.

Matthew Salem

I would say the $38 million is $37.5 and it will be correct? That is correct. Total exposure, the debt that's where I was going to finally, almost three graphics expose substrate.
So that's our maximum exposure of $37.5 million debt. The mortgage debt senior to us, which comprises the two together comprise $188 million is held by a third party.

Steve Delaney

And obviously, you're subordinate, of course there. So you need to focus on that when you look at the property value per share, so not to get ahead of things. Obviously, you're aggressively trying to get through these problems and the workout. I thought it was pretty clear a bold, but a strong move by the Board to make the meaningful cut in the dividend ahead of these resolutions and impact and obviously $0.39 in this quarter for reported, DE will be offset by the big number next quarter.
But it does appear by the time we get into early 2025 there, your run rate Yes. And I would expect perhaps all of us have to update our models would be in excess of your of your [$0.25] current dividend sort of. So I guess psychologically, I'm at the Board level, what does the board and what does management want to see in the portfolio before be reasonable to reconsider the dividend for a possible increase?

Matthew Salem

Thanks. Steve, it's not I can I can jump in again and I guess a couple of things. First of all, unfortunately, we just reduced the dividends and I think we're courts that are increasing at that in the near term here now. And most of the uplift is generally going to come from the recycling of REO assets into performing loans or are earning assets effect effectively, right and Young. And so when we start to think about the go, and that's why we keep referencing back to $0.12 a share where, okay, we're going to take title. We're going to be patient.
We're going to lease these. I think that's the best thing for our shareholders. The best thing for our balance sheet and over time and not paying out a higher short-term dividend. But if we optimize those outcomes and we repatriate that capital, then we'll be able to, we think, increased earnings by at least kind of $0.12 a share.
So that's that's really what we're focused on is that optimal optimization and implementation of that REO strategy. We'll see what the world looks like in six months, nine months, maybe other things that are have a material impact on that, obviously, whereas the interest rate environment will be a big driver here, and we've got a great portfolio but but that's really what we're mostly focused on is what is the path and the time line to get REO assets.

Steve Delaney

Got it. Well, congrats on the resolutions and appreciate the color.

Operator

Jade Rahmani, pKBW.

Jade Rahmani

Thank you very much. Just stepping away from the transitional CRE space and looking more broadly can you give any sense as to what's happening to CRE loans at maturity? What are you seeing from most lenders in terms of, you know, loans that come up for maturity the percentage that get refinanced or get modified get extended? How would you characterize it from here broader advantage?

Matthew Salem

Jade, it's Matt. Thank you for your question. I would say first of all I don't have exact numbers at my fingertips in terms of like what how much is repaying versus getting extended. Certainly, we're in an environment now where there there's a lot more extensions than normal payoffs.
And I think lenders are more than willing to work with borrowers. But on an extension scenario, if they were taking a little bit more time to get into our interest rate environment that's more and accepting, I guess of property values.
So I think everyone looks at the maturity wall. Maybe that's a little bit of a question embedded in your question, I never look at that maturity wall is like something that a real sign of imminent danger or issues. I think that if it makes sense and the borrowers are willing to put in a little bit of money.
I think almost all lenders are willing to kind of give another six months, 12 months to go down the road very, very few instances are two vendors like really need that capital back and force force people out of the portfolio so that the a little bit of it of how we think about it.

Jade Rahmani

Thank you. And on the flip side from a borrower standpoint and an OKRF. has some large real estate equity holdings. Our borrowers contemplating the outlook now it seems that there has been a material shift in the interest rate outlook higher for longer versus earlier in the year. Any color you could provide there.

Matthew Salem

We're seeing in embedded in my comments, just like the return to transaction volumes. And of course, when that inflation print hit and we got that rate move and that I think there was a little bit of uncertainty in the market around. How will this impact Realty equity participants? How they think about acquisitions, how they think about their ownership of assets and what we saw and it's early days.
But I think what we're seeing today is a materially different outlook than perhaps we saw in the fall where we had obviously a backup in rates as well, which is a view that I'm not going to necessarily change how I think about terminal interest rates. Terminal cap rates may have a little bit higher cost of capital in the interim here.
However, some might views around growth are more solidified today than they were six months ago. So people are like leaning into growth a little bit more than they had been and really kind of leaving exit caps around the same from what we can tell.
And therefore, them this trend has been again relatively, I think, immaterial to the mindset of institutional real estate investors again early. But that's certainly what we're seeing right now. And there's a lot of big transactions in the market that are pricing and that's what that's what we're witnessing.

Jade Rahmani

Thanks. And if I could add, I ask a follow-up on just can you give a range on what your views of the exit cap rates are, you know, touching on property type you can leave aside office?

Matthew Salem

Yeah. So I multifamily right now I would say entry caps are in the for Class A, somewhere around 5%, very high fours to low fives. I'd say it's kind of where those entry cap rates are. I think industrial is very hard to put a and these are all market and I think industrial is very hard to put up opinion just because what's the embedded gain-to-lease along the lease terms, what market are you and what's your box size of it there's so much variation there.
But I do think that that a lot of those assets are trading, call it, high fives, low sixes type of like a context. And then people running exit caps either at or slightly inside those levels to adjust for obviously rallies in the treasury over the over the next over the next couple of years.

Jade Rahmani

Thanks. That's helpful.

Operator

(Operator Instructions)
Don Fandetti, Wells Fargo.

Don Fandetti

Patrick. The two remaining Philly assets that you said you could possibly announce the sale. Is that indicative of more capital coming in for real estate or is it more you just saying, hey, you know, makes sense. Let's clear the decks.

W. Patrick Mattson

Hey, Don, Patrick. Yes, I think it's a couple of things on. I think there are signs in certain markets where when real estate gets to a certain value that there's interest, those two assets that we were and that you obviously have the ability to hold longer term. One is a well occupied office and the other is a parking garage. And I think when you talk about that profile of deal, even in this market, there's interest in. So I think as we indicated, we'll see how that transpires over the quarter from. But we do think there is some possibility to sell both of those properties.

Don Fandetti

Thanks.

Operator

Thank you. And ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Jack Switala for any closing remarks.

Jack Switala

Great. Thanks, operator, and thanks, everyone, for joining today. Please reach out to me or the team here if you have any questions, take care.

Operator

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