KKR Real Estate Finance Trust Inc. (KREF) Earnings Call Transcript

Good morning. I'm Francesca Kruk, a member of Barclays U.S. brokers, exchange and asset managers team. I'd like to welcome everyone to KKR Real Estate Finance presentation. I'm joined today by CEO, Matt Salem; and COO, Patrick Mattson. Matt joined KKR in 2015 from Rialto and is also a partner at KKR and head of its Real Estate Credit business. Patrick joined KKR Real Estate Finance from Rialto in 2015 as well and is also COO of KKR's Real Estate Credit business. Without further ado, I'd like to turn the floor over to Matt. Gentlemen, thank you for joining us today.

Great. Thank you very much, and I appreciate everyone's time this morning. I thought I'd spend a little bit of time talking about -- giving an overview of the company. And for those of you following along, we'll have some of the presentation up as we go along. For those of you that don't have access to that, this is on our website that you can download and we put up there this morning. And so I will reference some of the page numbers as you follow along. But again, thank you very much for your time. When you think about KKR Real Estate Finance Trust, I think there's a number of things that we'd like to highlight here. First of all, it starts with the sponsorship. This is externally managed mortgage REIT and managed by KKR. And KKR has a culture of collaboration, and I think you'll see that as we walk through this presentation that it really impacts all of our business and how we invest, how we source and how we finance our loans. At the same time, there's KKR as a largest shareholder in the company with about a 36% ownership interest. So when you think about skin in the game, KKR is clearly alongside all of you as investors or potential investors in KREF. Secondly, from a team perspective, we've been cycle-tested. And obviously, we're in another cycle today. But the leadership team worked through the GFC. We've been together building this company at KKR for over 5 years now. And many of us go back to predecessor firms working together as well. I think you'll see a differentiated investment strategy that we'll talk about today. We're really focused on institutional-quality real estate. We're predominantly senior loans in our portfolio. And with that institutional quality, we're focused on the largest markets and the best sponsorship. So as we dig into the portfolio, I hope that comes through. As I mentioned, best-in-class portfolio, 99.5% of our portfolio is comprised of senior loans. Importantly, if you think about it from a property type perspective, over 80% is comprised of multifamily and office loans. And we have less than 8% comprised of hotel and retail. So some of the more COVID-sensitive property types. So we are well positioned going into this environment, and the portfolio is performing very well. The other thing I'd like to highlight is within the transitional lending segment of the market, we're really focused on the lightest transitional properties. And so whether you think about the multifamily component or the office component, when we made those loans, there was a fair amount of base occupancy in the property today, and we're just effectuating the lease-up. So we do very little redevelopment. Construction lending is less than 1% of our overall portfolio. And again, we'll talk about that more. We've really differentiated ourselves on the liability side. And Patrick Mattson is with us today, and he'll spend a lot of time talking about that. And again, you'll see the KKR influence and be able to drive results, but 73% of our financing in place today is fully non-mark-to-market. So we don't have marks for capital events, capital markets events nor do we have marks for credit events on 73% of our overall portfolio, and that's a market-leading statistic. And then given the way our loans work and our focus on creating LIBOR floors pre-COVID, there's a lot of earnings power in the existing portfolio today. If you look at our existing portfolio, about 98% of our loans have a floor of at least 95 basis points, while the vast majority of our liabilities have no LIBOR floor at all. So it's creating some excess return to the existing rate environment. Now we turn to Page 6 of the presentation. I think many of you know KKR and the global reach that we have across the alternative investment space. On the right-hand side, you can also see our accomplishments in real estate. And what I would note is real estate is a strategically important vertical for KKR. It's one of the younger investment verticals that we have, started by Ralph Rosenberg, our Chairman of KREF, back in 2011. And so it's been a priority of the firm to grow this and commit capital here. And so you can see we currently manage over $12 billion of AUM. We have 90 people globally in the real estate business, and we have over $2.7 billion of our own balance sheet invested in our real estate businesses. And clearly, as I mentioned, KKR is the largest shareholder of KREF. I mean that's a good segue to Page 7, focus a little bit more on the U.S. real estate segment. But again, it's a very active business that we've been building for a number of years now. And I think it's important to note that we have both an equity and a credit business that sit alongside each other. And you can see the amount of scale that we've been able to create here. On the equity side, we have an opportunistic business. We have a core plus business and we have over $10 billion of asset value in that business today. And then, of course, within real estate credit, we'll talk about KREF today and what we're doing on the direct lending side, but we also have a very active securities investment business that we fund through private securities. But I think what's important to note when you put all this together, you think about the amount of information coming through the system, the contacts, obviously, and the relationships that we're building in the marketplace, which help fuel not only our deal sourcing and our pipeline, our originations but also the way we underwrite and we look at risk. And again, we're -- the culture here is one of collaboration and working together. And so as we underwrite transactions, we're bringing that equity lens to our underwriting. And clearly, from a sourcing perspective, it's working both ways as well. Turning to Page 8. It doesn't stop with real estate. We're really leveraging the entire platform within KKR. And when I think about as we underwrite specific credits, really on -- maybe the best example is on the office side as we're underwriting an office building and there's tenants in these properties that we're not familiar with, perhaps they're not a publicly traded company, we're really accessing our corporate credit team to help us evaluate the credit risk of that particular tenant more important now than ever in this COVID environment. At the same time, we're accessing the private equity team for similar views on industry trends and leverage profiles. We have an internal macro and asset allocation team that we can work with to develop themes. And I think you'll hear -- as you'll hear Patrick describe our liabilities and how differentiated those are in the marketplace, you'll start to ask yourself, well, how did we create these vis-à-vis our peers. And a lot of that comes to the capital markets business that we have here and their ability to leverage their relationships, KKR's wallet share across the street to really deliver best-in-class liabilities. And so really, you're getting the whole platform, and we use every component of it to make better decisions and to create a better outcome. Just quickly on Page 10. The Investment Committee, as you would expect, when I start to describe collaboration working together, it's really comprised of the senior members of both the equity and the debt side of the real estate team. You can see the top of the page here with Ralph and Chris, who are on the Board. And Patrick and I will speak to you today. And then on the bottom side, on the bottom right-hand side, the 3 partners in the equity -- in the equity business. And we want to bring diversity of thought. And so Jenny Box comes to us from our corporate credit business, where she co-heads our Special Situations and brings a different view in terms of relative value and what they're seeing on the corporate credit side. On Page 11, I think what's important here is just to note that we have a full-fledged team. We've got 22 people dedicated to this direct lending business. You could see on the bottom left-hand side, our senior investment team that is out sourcing transactions and really covering the market directly. And then the powerful engine behind that, all of our underwriting, we do in-house. And obviously, we're joined by other team members here with Chris Patterson, who joined us from Blackstone, heads up our Asset Management; Mike Shapiro, who's on the phone today, with our Capital Markets and Investor Relations business; and Rob Dusel, who I mentioned before, instrumental in creating some of the liabilities here. So the team has been in place for a number of years now. Many of us, over the last 5 years, been building the company to where we are today. And basically a full-fledged team at this point. So let's dig in a little bit on the investment strategy. Page 13 here, I think, really highlights the key components of what we're focused on. So #1, institutional quality real estate owned by the highest-quality sponsors. And so if you look on the left-hand side of this page, you can see our average loan size is around $134 million. I mentioned these numbers before, but 81% of our portfolio is in office and multifamily loans. And then the average occupancy in place today across those 2 segments is 75%. And so when -- and I'll give you some examples of the type of business plans and real estate that we lend on here in a minute, but just think about that level of transition that we have in the portfolio today, these are mostly leased assets. And that's, I think, created a good base level of cash flow to help support, obviously, our loan and the value of the property. And when we think about transitional lending, really, again, we're focused on the lightest transitional side of the market. So lending on existing assets. So less than 1% of our portfolio is in construction loans and lending either in -- with in-place tenancy, as I described earlier, or a quick lease-up and business plan. We're not doing a lot of big redevelopments, heavy repurpose, heavy renovation. On the market segment, again, given that we're focused on the kind of real estate we are, we transact predominantly in the largest market. So 77% of our portfolio is in the top 10 MSAs and 90% are in the top 30. And sponsorship here is critical. And this is one area where, again, I think we've really differentiated ourselves. We really only focus on the highest-quality sponsors in the market. So you can see some of the statistics here, but to give some names, some of our larger borrowers are Goldman Sachs, related companies, Oaktree, Morgan Stanley. I mean we're trying to lend to people like ourselves, to institutional investors in the real estate segment that have the experience to manage through cycles as well as the financial wherewithal to be able to withstand, obviously, changes in business plans or changes in the economic environment. And we've had this conservative strategy for some time now. And so as the portfolio has evolved, we've really moved into more senior first mortgage loans. We've had this office multifamily focus for quite some time now. For the last few years, it's been gravitating higher. Our average loan size continues to grow as we build out our institutional investor base. And on the bottom right-hand side, you can see the level of transition that we're willing to take. And if you think about how these loans are structured as an existing upfront funding, and then there's capital set aside for future renovations or value-add going into the property, you can see that only 9% on average is really what our future funding component is, which I think tells you a little bit about for the most part, we're lending on light transition or close to stabilized assets. Where we are in the market today from a strike film perspective. I think you've seen in the existing portfolio that I covered before, but light transitional loan size is ranging from $50 million to $400 million. We talked about the sponsorship. And these are short duration loans. So these are typically 2- to 3-year terms with a few extension options on the back, subject to property performance. And they're LIBOR-based loans. So the turn in market is around LIBOR plus 400. And that typically comes along with upfront -- an upfront fee. And we are actively quoting and lending in the market today. We think the market is relatively attractive. This -- our competitive set has gone through different variations of volatility. And really, the way we're positioned from a property type perspective, whether it's thinking about asset management, or from a balance sheet perspective, liquidity and the liabilities that you'll hear that we have, really, we've been front footed. And we are out in the market trying to create the new loans that will help fund earnings for the next few years. And we're trying to stick to our knitting here. I don't think we're looking to do anything different. We're still lending as if it's late cycle. So we're predominantly focused on the office and multifamily segments of the market. And as the market evolves, we can obviously open up that funnel. But as it stands today, we're still focused on what the existing portfolio looks like. Turning to Page 16. The funnel here. I think everyone's got this page in their deck, but it's a big market opportunity. It's certainly bigger today given a number of our competitors are more internally focused. So we've seen that competitive dynamic change during COVID and be quite favorable today. But if you look at just over the past 12 months, we've got about $45 billion of loans that fit our opportunity set. So again, this is whittling down the universe into what's institutional-quality real estate, what's light transitional lending. Of that $45 billion, we chose to underwrite $13 billion. So about 30% of that we took from the pipeline into an actual underwriting process. And then we ended up quoting about $8 billion and closed on $1.6 billion. But that $1.6 billion versus the $8 billion, you could see pretty high hit rate, almost 20% close rate there. So I think it shows you that we're very effective. We have very good relationships with our sponsors. There was a page earlier that noted that about 35% of our business is from repeat sponsors. These are all bespoke loans. We're not buying these syndicated loans. We make these ourselves with direct contacts with our -- through the broker channels, or obviously, we have direct contact an owner of the real estate as well. And so that really helps our close rate and the efficiency of our process. Let's dive into the portfolio a little bit more here. Top right-hand side, you can see predominantly senior loans I've mentioned, floating rate. On the map, you see the largest markets where we're concentrated here. And on the bottom right-hand side, you see the property type mix, which is obviously very important in today's market given COVID's various impacts on the different property types. And we break this out a little bit for you. So over half of our portfolio is multifamily. This is -- I think we're the highest among really our competitive set here in that multifamily segment. And the vast majority of that is Class A multi, which we like in this market. We think it does insulate us a little bit from what's been happening in the market as it relates to rent concessions and nonpayers. So about 87% of our portfolio is Class A. On the office side, the second largest component is 28%. And again, vast majority, 75% of that is Class A office, so exposing ourselves to better tenants. Higher-quality tenants have more likely ability to pay. And we've seen high collection throughout -- really, throughout our portfolio from the underlying tenants. And then you can see here, only 8% of our portfolio is comprised of the more -- what I think of as the more volatile and sensitive -- COVID-sensitive property types of hotel and retail. On Page 19, we give you a little breakdown of some of the statistics of the largest -- of our 2 largest segments by property type. Again, the multifamily and the office, you can see our low LTV in the mid-60s across both. And I think the most important thing to note here, again, when I talk about light transitional is kind of where we start and where we end. So on average, if you look at this multifamily component, we're lending on assets that have in-place occupancy of around 53%. And fast forward to today, obviously, there's been lease-up, and they're at 74% today. So you're starting with, again, this base level of cash flow from the tenant base. And a lot of what we do on the multifamily side is construction takeout. So property is built. It's delivered. And we're coming in, giving them that bridge loan effectively to give them time to lease it up. And then we'll get taken out by an agency loan or by a more stabilized lender like an insurance company. And they can -- or they can obviously sell the property as well if they want to move on. On the right-hand side for the office, a little bit more conservative on the office side. There, we're lending at basically 72% going in occupancy, and that's leased up to 78% today. And importantly, when you look at that lease term that's in place today, it's 6 years of remaining average lease term for that 78% occupancy. So we've got that base level again of tenancy and cash flow coming through for a sustained amount of time. And importantly, the co-working exposure here is very low. Less than 1% is in co-working. I'll just highlight on Page 20 and 21 for reference, we do give you our 3 largest multifamily and office loans. So if you want to look at some of the case studies and examples that we have in the portfolio today, I would point you to those pages. And then on Page 22, a couple of quick comments. Obviously, in this market, we're focused on asset management. We do a full review of every loan in our portfolio on a quarterly basis. And our portfolio has been very strong, 90 -- almost 100% performing collections at the underlying loan level. We have updated some of our risk ratings for the environment we're in now. And so going into COVID, basically, we had 0% of our loans on watch list. And you can see the transition here, about 16% of the portfolio today is risk rated 4 and 10 basis points or so as risk rated 5. But that 4 bucket is the one we're most focused on, and that's really the -- what I think of as the watch list component of our loans. And just to be able to give you some transparency, if you turn to Page 23, we list out what that component, what's in that bucket. So you could see it's a handful of loans. And it's really all the loans that, again, were impacted by COVID. And so for the most part, it's our hotel loans and both of which we've entered forbearance agreements with. We gave some partial deferral of debt service and return for the sponsors coming out of pocket and contributing more equity to the loan. And then we have some for-sale condos in New York, and obviously, retail property. But really, this is the 16% that as we look at it, that could be impacted. Again, this is a watch list. We don't expect issues with all these loans, but it's the ones that, from an asset management perspective, we're the most focused on. With that, I'm going to stop. I'll turn it over to Patrick, and we can come back at the end and give you a summary and answer any Q&A that you have.

Thanks, Matt, and thanks, everyone, for joining us today for the presentation. I'll start this out on Page 25. This is a page that we're really proud of. As Matt talked about, in the last 3 years, we've really focused on kind of building out a diversified set of financing, really focused on non-mark-to-market capacity. And that's been done in conjunction with our KKR Capital Markets team. So you can really see the power of the KKR brand here at work. As of quarter end, we were 73% non-mark-to-market. That's non-mark-to-market, full stop. The remaining 27%, which is our traditional repos, and you can see that on the right-hand chart on the page, is only subject to credit marks only. So there are no spread marks. There's no capital markets marks. That's just credit marks. We continued to diversify this financing earlier this year with the addition of a $500 million non-mark-to-market warehouse facility, which we closed on. We followed that up in the third quarter of this year by closing a $300 million term loan B that just closed. And the use of those proceeds for this quarter and beyond will be to pay down some debt and really give us capital to put the work in our growing pipeline. The growth in this non-mark-to-market financing has really allowed us to lower the risk of our liabilities but at the same time, maintain our target leverage levels despite some of the recent volatility that we've had in the market. Well, the next page, 26, you can see on the left-hand side really the detailed breakdown of all of these facilities. One, you can see sort of the breadth of the facilities that we have here. We highlight also the running cost of capital that you can see, which has been very efficient, best in class in the market as well as the advance rates that we have on each of these respective facilities. We also highlight, as you can see, just the non-mark-to-market, which I just touched upon. As we've shifted our liability mix more toward non-mark-to-market, you could see that our target leverage on some of these non-mark-to-market facilities is 3x or up to 4x in some cases, while the term credit facilities at the top there you can see is at 71.5%. We've got more capacity or more leverage available to us, and we've just chosen not to unveil ourselves to that leverage just to reflect that conservative event that we've got on this liability structure. On the right-hand side, you can see our total leverage ratio. It's in our target range of kind of mid- to high 3s at the moment. On the -- lastly, I'd say, on the bottom left-hand side of the sheet, you can see our term loan facility, our CLO and our senior loan interest, which totaled about $2 billion. In addition to being non-mark-to-market, those are also matched term financing as well as nonrecourse financing. And starting in the third quarter, we'll include the term loan B on this presentation as well. We'll go to the next slide. And here, we've got a highlight of our repo facility. This is our traditional repo facility. You can see it's just over $1 billion, about 27%. I want to highlight that unlike a lot of the repo that was done pre-global financial crisis, this repo looks very different. As I stated before, it's only marked to credit only. You can see that on the bottom of this chart, and that's applicable for all of these facilities. All these facilities have got maturity dates that give us ample runway. We recently extended the Goldman Sachs facility to October '21. And in addition, we've got 2 years of runway beyond that. We also provide some details here, just in the types of loans that are being financed here. You can see it's 11 loans at around $1.5 billion. And about 3/4 of this are multifamily -- Class A multifamily and office. The last thing I'd just highlight on this page is that our exposure to these institutions, which are some of the biggest lenders in the repo space, is both small in terms of our exposure as well as their outright dollars to us. Turning to Page 28. This is our liquidity snapshot. As of the second quarter, we had over $431 million of total available liquidity. I mentioned the closing of the term loan B in the third quarter. Today, just our cash liquidity. So our cash plus undrawn revolver totals over $570 million. So we've got ample liquidity to kind of manage and continue to grow the portfolio. In addition, we would expect that over the coming quarters, that will get additional repayments that will supplement this liquidity. On Page 30, this is a summary of our LIBOR sensitivity. Our portfolio is almost entirely floating rate. And 98% is -- and 98% is sort of subject to a floor that's at least 95 basis points. Matt mentioned earlier our liabilities only have a -- only 5% of our liabilities actually have a floor above a 0. So in this current rate environment that we've seen over the last couple of quarters, there's tremendous earnings power for the company. We saw that demonstrated in the second quarter. And obviously, as we've seen LIBOR over the last several months, we'll continue that trend with LIBOR at sub-20 basis points so far in the third quarter. And you can see the impact here on a per quarter basis using a baseline of 99 basis points. So the impact of these LIBOR floors has been really powerful from an earnings potential. Now turning to Page 31. These are our operating results as of the second quarter. We reported earnings -- core earnings of $0.45. That marked the fifth out of the last 6 quarters where core earnings was at or above our paid dividend of $0.43. You can see here on the right-hand side, book value continued to grow in the second quarter. That was driven on the heels of share repurchases in the first and second quarter as well as some reduction in CECL over the second quarter. Finally, I'd like to mention that we continue to see strong performance across the portfolio. We had nearly 100% collections in the month of August, and that was followed up in September as well, which has driven earnings obviously higher over the quarter as we reported in the second quarter. And with that, let me turn it back to Matt.

Great. Thanks, Patrick. So just in summary, let's talk about the asset side. Really best-in-class investment portfolio, institutional-quality real estate, institutional-quality sponsors. Look at the underlying property mix, 80% plus is in the multifamily and office segment. Again, little exposure to more COVID-sensitive property types of hospitality and retail. On the liability side, best in class with that 73% fully non-mark-to-market for both capital markets and credit. And we've got ample liquidity. As Patrick mentioned, when we look at both cash and that access to the revolver, we have over $570 million of liquidity right now. And of course, the sponsorship. You look at the sponsorship, it really has -- gives us the ability not only to source deals but to underwrite them and finance them in the most efficient way and the most -- and the safest way. And then finally, I'll just note that we're on the offense. We're actively trying to lend in today's market, which we think is attractive, and really sticking to what we've done in the past, but hopefully, capturing a little bit excess return in the market that's got a little bit more volatility. And the loans are a little bit more structured and a little bit lower leverage as well. So we like what we see today, and we have the liquidity to take advantage of it. So with that, I'll stop, and we can open it up for Q&A. But again, thank you, everyone, for joining. We appreciate you giving us the time.

Just a reminder, if you have questions, please e-mail them through to us. But maybe we'll start with one. Matt and Patrick, you highlighted how little exposure you have to COVID-impacted industries, less than 8% in hotel and retail. But given the environment that we're in, how do you think this will lend itself to consolidation in the industry overall?

Yes. I mean I think it's a little bit early to tell. I think that firms will kind of look at their existing portfolio and think about the growth profile of the company and their cost of capital and where they sit. And I think there will have to be some -- there'll probably be some consolidation over time. But that phase isn't upon us quite yet. I think what we've seen from some of the peers is more of the rescue capital and making sure that the liquidity is there. But we haven't quite seen that kind of M&A wave come through yet. So time will tell, but I expect a little bit of consolidation going forward.

And speaking of capital, you are in a unique position where you put capital out. Can you talk a little bit more then about the lending environment, sort of where you're seeing opportunities or any areas that you're still staying away from and what competition there might look like?