Good morning, and welcome to the KKR Real Estate Finance Trust Earnings Call for the First Quarter of 2020. Please note this event is being recorded. I would now like to turn the conference over to Michael Shapiro, Head of Investor Relations. Please go ahead..

Thank you, operator. Welcome to the KKR Real Estate Finance Trust earnings call for the first quarter of 2020. We recognize that these are unprecedented times. We hope that all of you and your families are safe and healthy.

As you could expect, we are hosting today's call from various locations, so please bear with us should we experience any technical difficulties. Today, I am joined on the phone by our CEO, Matt Salem; our President and COO, Patrick Mattson; our CFO, Mostafa Nagaty; and our recently appointed Vice Chairman of the Board, Chris Lee.

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..

Thank you, Michael. Good morning and thank you for joining us today. Our first priority is the health and safety of all of our stakeholders. While we have spoken to many of you recently, our thoughts and prayers are with you and all those who have been impacted by the COVID-19 pandemic.

Our entire team is working remotely and continues to be highly efficient. Given the recent volatility, we have increased our level of communication with our board members, shareholders, borrowers and lenders to ensure transparency and proactively address potential issues.

While it seems like many months ago now, we announced this past quarter that my partner in the business, Chris Lee has joined our Board of Directors as Vice Chairman. I want to thank Chris for his leadership with KREF since its inception. We will continue to work closely with Chris on all of our investing and strategic initiatives.

Also, as part of the board transition, Craig Blanchard from Makena recently stepped down from the board. We want to thank Craig for his leadership since the IPO and to thank McKenna for being one of our lead pre-IPO investors. Craig, we wish you all the best.

Since our IPO almost three years ago, we have been focused on conservatively managing the company across both our assets and liabilities.

As of quarter end, the company had approximately $450 million of liquidity, including approximately $370 million of cash while we have been laser-focused on lowering the risk profile of our liabilities, by diversifying and increasing our funding sources away from traditional bank repurchase facilities to those that are non-mark to market.

As of quarter end, 73% of our outstanding secured financing was completely non-mark to market. While none of us could have predicted this pandemic, our portfolio was purpose-built for the later stages of an economic and real estate cycle..

Thank you, Matt, and good morning, everyone. Following our IPO, nearly three years ago, we devoted a considerable amount of time and resources, working closely with our internal KKR capital markets team to diversify our financing sources, and increase our non-mark-to-market financing capacity.

As of quarter end, 73% of our in-place secured financing was completely non-mark to market, compared to 13% in 2017. The growth of non-mark-to-market financing has allowed us to lower the risk of our liabilities while maintaining target leverage levels despite the recent volatility.

We continued to add capacity in the first quarter with the closing of a new $500 million non-mark-to-market warehouse facility. In addition, we increased the size of our corporate revolver, which matures in December 2023 by $85 million to $335 million. Our traditional repo financing represents 27% of our outstanding secured financing.

Unlike facilities prior to the global financial crisis, our repo facilities are marked to credit only..

one, our cumulative CECL reserve which reduced our book value per share by $1.22; and two, our accretive repurchase of 1.6 million shares of our common stock in the first quarter, which contributed $0.19 to our book value per share. Additional details regarding our book value per share go forward can be found on Page 7 of our supplemental.

Finally, I will conclude my remarks with an overview of our CECL approach and our thoughts on the CECL reserve in light of the current environment. Our new CECL standard became effective for us on January 1.

As disclosed in our Form 10-Q, we utilize affordability of default, loss given default model, combined with a subset of historical loan loss data license from KREF that most closely represents our focus on larger loans in major markets.

Certain loans that did not fit the model were evaluated using a probability-weighted expected cash flow approach concerning varying economic and market conditions.

In addition to the $15 million or the $0.26 per share day one CECL reserve recorded as a reduction to our January 1 book value, we recorded an incremental $55.3 million or $0.96 per share of additional CECL provision in our first-quarter income statement, resulting in a cumulative book value impact of $70.3 million or $1.22 per share.

The $30.3 million year-to-date cumulative CECL impact, of which $4.3 million is attributable to unfunded loan commitments represents 137 basis points of our aggregate portfolio outstanding principal balance.

The increase in our CECL reserve during the quarter compared to our day one adjustment was primarily driven by changes in the macroeconomic outlook, resulting from the projected impact of the COVID-19 pandemic. In summary, we are taking a conservative posture today and will remain very selective in deploying our capital.

We have a strong liquidity position. We have a conservatively built portfolio matched with lower risk, non-mark-to-market liabilities..

The first question comes from Jade Rahmani of KBW. Please go ahead..

Thank you very much, and glad to hear from everyone.

In terms of the magnitude of deleveraging, can you put some parameters around that, perhaps? For example, should we expect credit facility borrowings outstands to perhaps be reduced by somewhere in the range of 10% to 20% over the next quarter or so?.

Hey, Jade, good morning. It's Patrick. I'll take that one. So a couple of things, I guess, first, just to level set here. Obviously, we're talking about the 27% of our facilities that are not non-mark to market. And within these facilities, there's no capital markets. So anything that we would be doing would be proactive.

Just to be clear, we haven't been margin called on any of our facilities to date. But to get to your direct question, I think we would think about something more on the lines of sort of a 5% to 10% deleveraging as opposed to a 10% to 20%..

Ok. It appears here that I believe accidentally disconnected himself. Maybe he was unmuting himself. So in this case, what I'll do is go to the next question, who is Stephen Laws of Raymond James. Please go ahead, sir..

Can you talk about the buyback activity and your considerations into liquidity and valuation relative to book. At what point does the buyback become less attractive and it's more about maybe building up some liquidity and dry powder to capitalize on opportunistic new investments when the market opens back up.

Just any color kind of how you think about the economic return of those two options from here as you look forward..

Yes. I can take that one, and thank you. Thanks for joining us, Stephen. It's Matt here. There is, obviously, an economic balance that we have to take versus preserving capital and making new loans or just against preserving liquidity, I think some of the extraordinary price action that we saw in March, obviously, let us down the path to buy back stock.

And we had a lot of liquidity, and I hope that's what you and our shareholders would expect us to do is be on the offensive and inactive in the market trying to buy back stock. Obviously, the environment makes us a little bit more cautious, but it doesn't mean we aren't going to be opportunistic when we see our stock trading at those levels.

And I think we gave you a sense of how accretive it was in total, when you factor in a few of the shares that we bought post quarter end, it was around $0.22 of accretion overall to the balance sheet. And we're buying those at about a 14% dividend yield.

And so you think about that versus where you could potentially make new loans and the uncertainty around that that we thought it was the right thing to do to use that capital to buy back stock..

That certainly is very accretive to book value as we saw in the deck. This may have been at least somewhat down the path Jade was headed. But can you leverage, obviously, there's an accounting impact or a math impact from the CECL.

How should we think about those levels going forward? Will we continue to add back that reserve and look at leverage to an adjusted equity and as you mentioned, I think, a decline of 5% to 10% on the funding balance.

Will you view that new level is more of where steady state is? Or is it something that goes back up in a year or two back to where we were previously?.

So, in terms of leverage, I guess, first, I would say, from a portfolio standpoint, at this point, we're fully deployed. So that's the first thing.

I think the second thing, as you saw, we reported that total leverage number, which includes all of our non-mark-to-market, nonrecourse, financing in there, but presented on a look-through basis, was higher.

Obviously, when you back out for the CECL reserve, you'll see that we're more in line at the 3.7 times, which was sort of marginally up from sort of year-end. That feels the sort of mid-threes, mid- to high threes, which we've talked about in the past, feels like the right sort of near-term range for us.

I'm not anticipating a significant move off of that. The only thing that could change is if we proactively take some steps to reduce some of our leverage in certain facilities..

Great. And lastly, looking at Page 19, Loan 24 looks like the only one with a max remaining term of less than a year. It's a retail asset in Portland.

Any updates there on discussions you've had with that borrower, given the near-term loan maturity?.

Right.

On that facility, I guess, you're talking about the facility that's maturing later this year?.

Well, Loan 24 to a retail asset in Portland, Oregon. Looks like it matures in about six months..

Right. So we're in active discussions with that sponsor regarding that loan and sort of that business plan. So that's, obviously, one of the ones that we're working closely with the sponsor through this crisis and managing toward that maturity date..

Okay, great. Well, appreciate the color you gave. Thank you..

Thank you. The next questioner is Jade Rahmani. I'm sorry, your line have dropped before, from KBW. Please go ahead, sir..

Yes, thanks very much. Sorry, I'm not sure how I got cut off. But can you talk about the multifamily portfolio? I think there's somewhat of a healthy debate right now about how multifamily may perform. You mentioned 88% of it is Class A.

I assume the inference being that the underlying tenants in those apartments are better equipped to deal with the economic shortfall that's being experienced right now.

How do you expect multifamily to perform? And can you give any update as to your multifamily loans?.

Hey, Jade, it's Matt. I guess, I can take that. You're right in that. I think the reason we broke that out this quarter in our supplemental to provide that additional information.

I think you could see a different level of underlying tenant collections depending on, obviously, the quality of the real estate, the rental level and the type of tenant and what kind of jobs they have there.

So I think when we look at -- I said this on our prepared remarks, but when you look at the collections in April versus March, they were in line month over month. And I think everybody is, obviously, going to look at May and see how those come through. But so far, the performance has been strong.

And these are predominantly, obviously, salaried employees, right, that are able to work from home while this is going on and are still, I would say, earning and income. So I think we're always thinking about where the risks in the portfolio. And clearly, if you saw a very prolonged deep contraction in the U.S.

economy, and that starts to filter through to salaried, white-collar jobs, etc. That's what we're watching and trying to understand how that could potentially come through and impact our assets. Most of that multifamily is pretty well leased. So it's about 74% on average leased.

So it's a little bit less about the lease-up for us right now and more about the underlying collections at the property level, which is, obviously, a good thing. So I think that's how we're thinking about it. I think we feel good about it today. But obviously, in a market like this, we're closely monitoring it..

And what has been generally the tone of the actual owners of those buildings?.

I don't think anybody's business as usual right now, right? I think anybody that on the company or our property is taking inventory and looking around corners and making sure we understand what may happen. But I would say the tone has been pretty positive and constructive.

And I wouldn't say any of them are thinking that there's going to be a big impact at this point. But again, we've got May and June, and there'll be other data points to look at. But I would say, so far, the tone has been pretty positive..

Can you also touch on the office portfolio? You mentioned 75% Class A? Do you expect that to be a more durable asset class? And also, is there any either direct co-working exposure or buildings that are in lease-up that have perhaps some competition from buildings that had been exposed to co-working?.

Yeah. Let me take that one, and I'll pull up the exact co-working number here. Right now, the direct co-working number is less than 1% of our office portfolio leased by co-working tenants.

And if you look at where -- like, for instance, WeWork has their biggest market exposure, like New York City, San Francisco and Los Angeles in the U.S., we don't have any office assets those top three markets. So obviously, it's co-working is a component of every market.

But I don't think that we look at our portfolio today and say we're particularly concerned about what's going on in the co-working space as it relates to existing tenancy, obviously, but also in terms of just ability to lease up. And similar to my multifamily comment, the office assets are about 75% leased as well on average.

So there is a base level of tenancy there, a base level of cash flow there that could help, obviously, support the property and support the debt service. So we'll continue to follow those closely. But from where we sit today, I think we feel good about that overall exposure..

OK. In terms of the earnings and dividend trajectory, are there any comments you could make high level about some baseline expectations you think is reasonable to think around.

I think on Blackstone's call, BXMT's call, they said the board would make a decision regarding the dividend in June, which, obviously, leaves open the potential for a reduction, although they didn't say that. I want to hear how you guys are thinking about things..

Sure. I'll touch on the dividend. I would say our view on the dividend hasn't changed. It's our priority to pay a cash dividend. We target a minimum of 90% of our annual taxable income. Obviously, we just paid a dividend two weeks ago.

And I think if you look at the company today, we've got lots of liquidity and additional earnings power from LIBOR floors, but similar to what you commented on before, like our board meets in mid-June. And they'll be able to incorporate whatever new information comes out from now until that moment, and we'll make the decision at that point..

The next question comes from Rick Shane of JP Morgan. Please go ahead..

Hey, guys. Thanks for taking my questions this morning. And I just want to say how much we appreciate your disclosure. I think it's very helpful. I did want to touch on some comments you guys made about draws on committed loans. You're talking about roughly $25 million a month through year-end.

And compare that to what you might expect in terms of repayments. If we look at Q1, repayments were about $60 million a month. So, I suspect that was probably very front-loaded. Last year was $150 million a month on average.

I'm curious what you would expect as we move through 2020 in terms of repayments?.

Rick, good morning. It's Patrick. I'll take that one. So I guess, first, on the fundings, as you can imagine, it's not a precise science. So, we're forecasting out what we expect to pay, and part of that's a little bit based on what we've paid historically.

But as I mentioned in the comments, there are a number of factors that could lead to a slowdown in that trajectory, including delays in CapEx spending. A number of our fundings are hurdled. About a third of them are hurdled. So, that can cause sort of further delays. So, we're doing our best to sort of map that out.

And then, as I also indicated, we would expect that a number of those payments we will have financing against those. And so that will largely cover a good portion of our expected fundings. On the prepayment side, if it was difficult before, it's, obviously, even more difficult now to assess what the repayment schedule could look like.

That said, there are a number of loans just that are near stabilization that are in active discussions with lenders to refi those positions. And given some of the nature of the profile of the assets, the lower leverage, they're having dialogue with both sort of floating rate and fixed-rate lenders. So it's difficult to predict.

But given the size of some of those loans, some of those prepayments could be rather meaningful as we forecast out in the second half of this year..

And thank you for taking an attempt to sort of dimensionalize those fundings as we move through the year. Look, you guys intimated to the idea that you're sort of -- the portfolio is full right now. And obviously, it makes sense to preserve liquidity in order to meet those future -- those commitments.

How do you have the conversation with borrowers about, hey, we're going to be shut down for a little bit? Presumably, there's not a lot of activity, anyway.

But how do you manage that in terms of relationships?.

Yes, it's Matt. I can take that. I think everybody is, to some extent, in a similar place. And so there's not an expectation that we're kind of open and actively lending today. And quite frankly, obviously, some of it's capital and being conservative.

And some of it's just logistics, right, like how do you go site inspect the property and how do you get an appraiser out there. And so I would say, largely, it's not just the lending community. It's also on the equity side and the acquisition side, everything has slowed down until we can get commerce going and the shelter in place starts to diminish.

So I think everyone is very, they understand that. It's not a difficult conversation. I think everybody is rooting for each other here and making sure that as the economy recovers and we can leave our homes that we can kind of get things going again from a transactional perspective..

Got it. Okay. Thank you very much, guys..

The next question comes from Steve Delaney of JMP Securities. Please go ahead..

Good morning, everyone. And just one question from me. I wanted to ask on your CECL reserve of $70 million.

Can you comment as to whether there's any meaningful specific reserve on an individual asset in that total figure?.

Good morning, Steven. This is Mostafa. Thanks for the question..

Hi, Mostafa. Yeah..

How are you?.

Good..

So our CECL reserve is basically, for most of our loans, it's the same approach. We use this property as a whole clause given the fourth model supported by historical loan loss data from KERF to project a low-level loss reserve for each single loan that we had.

So there's not really anything outside of the ordinary other than we're just running the model. So there is no -- and the increase --.

Okay. Sort of on just the portfolio, nothing jumped out as one particular loan that required a loss reserve much greater than KREF would have indicated..

That is correct. And the increase was primarily driven by the macroeconomic forecast given the COVID..

COVID, sure. Yeah. Well, let me explain why I asked. So you had $70 million. You have $5.2 million of outstanding principal. So I get roughly 135. I think you might have mentioned 137, Mostafa. Well, we had BXMT's call at 10 A.M., and we had the press releases last night. And I calculate 70 basis points for them on outstanding principles.

So your reserve is almost two times what BXMT put up. And you have far less hotel in retail at 11% combined versus their 20%, not to mention their 30% foreign exposure. So not at all trying to trash them or anything. This is new for all of us. But that was the reason for my question.

And I think, over time, it will be interesting -- I'm sure all the analysts on this call, this is the first quarter, but I think it will be interesting to track the level of your CECL reserve versus your outstanding principal balances. And I'm sure we'll figure out how to refine that. But obviously, part of the hype is....

Yeah..

Go ahead. I'm sorry..

Yeah, that's is a very good question, Steven. This is good observation here. I would just say that we have been very conservative on our estimates. And we stayed away from make any subjective adjustments on the back end to the results.

And we just kind of start with the model and just basically -- the change was really driven by the macroeconomic forecast. And we believe it's a very conservative reserve, and as you said, time will tell..

Well, congrats to you for being conservative at this uncertain time. And everyone, stay well. Thank you for the comments..

The next question comes from Arren Cyganovich of Citi. Please go ahead..

Thanks. I apologize if this has been asked. My phone has been going in and out.

But have the repo lenders asked to change the advance rates at all? Are those expected to stay stable through the deleveraging?.

Arren, good morning, it's Patrick. Let me address that. I guess, first, I would say that as it relates to kind of the landscape of repo lenders, if you look across our facilities, generally, we're borrowing in kind of the 70% to 75% range. I think from our discussions with them, that's still a consistent area where they would be willing to lend.

I think across the broader market, you'll see that there is leverage that is available at a higher level, but we have not availed ourselves to that leverage on sort of repo. So I think that that's still sort of largely intact. I think we're looking to maybe be proactive here is that we've got liquidity position.

As you've seen, we've taken a lot of effort over the last few years to really bulk up the non-mark-to-market financing. And so if we can do that in our repo facilities by offering some amount of partial deleveraging in exchange for non-mark-to-market holidays, we're going to look to avail ourselves to that in this market.

And so I think that that is available out there. We're exploring that. But as it relates to the existing assets on the line and for future assets, at the moment, I'm not expecting sort of a material change in leverage..

Thank you..

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

Thank you. And thank you, everybody, for joining us today. We appreciate the time and hope that you stay well and healthy. And if there's any follow-up questions, please feel free to reach out..

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect..