Earnings Call Transcript - KREF Q4 2024

Operator, Operator

Good morning, and welcome to the KKR Real Estate Finance Trust, Inc. Fourth Quarter 2024 Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. And I would now like to turn the conference over to Jack Switala of Investor Relations. Please go ahead.

Jack Switala, Investor Relations

Great, thanks, operator, and welcome to the KKR Real Estate Finance Trust earnings call for the Fourth Quarter of 2024. As the operator mentioned, this is Jack Switala. This morning, 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-K for cautionary factors related to these statements. Before I turn the call over to Matt, I will go through our results. For the fourth quarter of 2024, we reported GAAP net income of $14.6 million or $0.21 per share. Book value as of December 31, 2024, is $14.76 per share, which is relatively flat quarter-over-quarter. Distributable loss this quarter was negative $14.7 million or negative $0.21 per share. We have a $0.25 per share dividend, which yields 10% as of yesterday's closing price. With that, I'd now like to turn the call over to Matt.

Matt Salem, CEO

Thank you, Jack. Good morning, everyone, and thank you for joining today. Before we begin, we first wanted to acknowledge the devastating wildfires in California. Our thoughts are with everyone that has been impacted, and our heartfelt thanks to all the first responders. Before going into our results, I thought I would discuss our 2024 achievements. First, I wanted to highlight KREF's ability to leverage KKR's significant resources and information. KKR manages approximately $80 billion of real estate assets globally, with approximately 140 professionals we have been able to utilize all our resources across asset management, sourcing, underwriting, and capital markets. Just within real estate credit at KKR, we are active across the United States and Europe in both loans and securities and we invest across the risk-reward spectrum through our bank, insurance, and transitional pools of capital. Our dedicated K-Star Asset Management platform now has over 55 individuals with expertise in asset management, special servicing, underwriting, and REO. This team manages a portfolio of over $36 billion in loans and is named Special Servicer on an additional $45 billion of CMBS. Turning to KREF. This was a year of transition. Our posture during this challenging environment for real estate has been to transparently and proactively address issues, and we think this approach has led to better asset management outcomes. Over the course of the year, we have decreased our watchlist percentage from 13% as of fourth quarter of 2023 to 8% today. As for our REO assets, we've begun to see green shoots in the office and life science sectors, and it's reentering the market, and we have responded to a number of RFPs. Investor sentiment is slowly rebounding and liquidity is beginning to return for the highest-quality assets. The CMBS market has seen a number of large office transactions with over $3.5 billion of office SASB issuance in 2024 and a healthy 2025 pipeline. We think our patience on these high-quality assets will optimize shareholder value. As a reminder, as we repatriate the equity in the REO portfolio, we believe we could generate an additional $0.12 per share on our distributable earnings per quarter. With the assistance of our KKR Capital Markets team, our liability structure remains a differentiator for the company. We have diversified financing and 79% of our financing is non-mark-to-market. We have strong levels of liquidity with $685 million available at the end of the fourth quarter. Although we don't have any corporate maturities until 2027, the debt capital markets are healthy and we continue to watch for opportunities to optimize our capital structure and further extend maturities. Since our last call, sentiment around commercial real estate has continued to improve and transaction volumes are increasing quarter-over-quarter. The higher U.S. treasury market may dampen some acquisition activity but we have a robust pipeline and there should be ample opportunity to lend on reset values. In January, we closed two loans for approximately $225 million. Looking ahead, we have consistently stated that while we are not fully out of the woods and anticipate further credit migration, we think we have dealt with the majority of the issues in the portfolio. Before I turn the call over to Patrick, I want to reiterate our optimism heading into 2025. We continue to feel confident in our offensive positioning and look forward to the opportunity that we have in front of us. With that, Patrick can take it from here.

Patrick Mattson, President and COO

Thanks, Matt. Good morning, everyone. Fourth quarter repayments exceeded $450 million comprised of six loans secured by multifamily and industrial properties, as well as the par sale of a Dallas office loan. Full-year repayments totaled $1.5 billion, representing approximately 19% of our portfolio. The reported fourth quarter distributable earnings prior to realized losses of $0.31 and DE of negative $0.21 per share, which includes the realized loss on the San Carlos Life Science loan. We now have four watchlist loans in the portfolio, representing 8% of the loan portfolio compared to 13% a year ago. While additional watchlist loans would not be surprising over the course of this year, we remain confident that we are well beyond the peak stress. With excess liquidity, a stabilizing portfolio, and leverage at the low end of our target, we are actively looking to invest repayments into new loans. Repayments are expected to exceed $1 billion again this year and given our current leverage levels, we anticipate originations to outpace repayments in the near term. We closed two loans for a total of $225 million last month, including a four-property multifamily portfolio of newer vintage and recently renovated assets with a business plan to improve physical occupancy and burn off current concessions. Turning to our CECL allowance and Watch List. As we suggested in the previous earnings call, in the fourth quarter, we modified the San Carlos Life Science loan and subordinated a portion of the loan to new sponsor equity. The $36 million subordinated note was written off and the corresponding CECL reserve was released. Subsequently, the restructured and reduced senior loan was upgraded to a risk rating of three. Our total CECL reserve decreased to $120 million or 92% of the portfolio is risk-rated 3% or better. On our Watch List, we continue to make progress on our West Hollywood Multifamily loan, and we are continuing down a path to ownership and subsequent condo sellout. We will keep you updated on the progress in the coming quarters. As of the fourth quarter, our debt-to-equity ratio is 1.6 times and total leverage ratio is 3.6 times. KREF's leverage at this point is on the lower end of our target zone, so we are actively originating loans. As part of our investment allocation, we've continually looked to evaluate share repurchase opportunities. Prior to the fourth quarter, we bought back almost $100 million of stock since inception of the company. In the fourth quarter, we added to that total, repurchasing $10 million of KREF stock representing a weighted average stock price of $11.64. We've made great progress on our watchlist over the last 12 months and remain excited about the current market opportunity. This should be a strong repayment and origination year for KREF. The lending market is attractive and we plan to be active. We feel confident in our positioning from a portfolio quality, liability structure, and leverage perspective, and look forward to the opportunity ahead in 2025. Thank you again for joining us this morning. And now we're happy to take your questions.

Operator, Operator

We will now begin the question-and-answer session. The first question will come from Tom Catherwood with BTIG. Please go ahead.

Tom Catherwood, Analyst

Thanks and good morning, everybody. Maybe starting with repayments. Obviously, huge jump in 4Q. You had alluded to that, with 3Q earnings just that you expect that pace to be accelerated. How has that pace trended with the steepening of the yield curve? Kind of has that slowed as we've begun 2025, and how much of that do you kind of expect of the $1 billion-plus dollars of repayments, do you think that that's likely early '25 event or should it come in kind of evenly throughout the year?

Patrick Mattson, President and COO

Tom, good morning. It's Patrick. I'll take that question. So, you're right, we did have a pretty meaningful acceleration in the fourth quarter. As you know, our loans are pretty chunky. So, we get a few more repayments in any one quarter and that can sort of drive the numbers. Obviously, that was at a time when we saw rates back up and there wasn't a meaningful impact in repayments. I don't see that as a main driver for the repayments. A lot of these loans have reached their business plans and it's about optimizing the refinance for our counterparties. So, I don't see a material impact there. In terms of the forecast this year, again, difficult sort of quarter-by-quarter, we certainly think it's over $1 billion this year. If I had to lean one way or another, I'd probably say that's middle to sort of back-ended, but it's really difficult to forecast. What we saw in the fourth quarter was an acceleration of some repayments that we had forecasted to repay in 2026 and obviously came early.

Tom Catherwood, Analyst

Got it. Appreciate that. And Patrick, just want to make sure I heard you right. Did you say you expect originations to exceed repayments in the near term in your prepared remarks?

Patrick Mattson, President and COO

That's right. And that really stems from the fact that we're at the low end of our leverage target here. So, as we start to redeploy the capital, we think there's an opportunity for us to get ahead of some of these repayments, but also get back into the mid-range of our leverage ratio. So out of the gates, we had a pretty strong January to start with. There were no repayments that came in that month, so already in the first quarter, we're seeing the trend that I was discussing.

Tom Catherwood, Analyst

Great. Can you discuss the types of asset classes you are targeting in your pipeline moving forward and how that compares to the pipeline before the pandemic or around early 2020, considering the insights shared about the hospitality loan in Tennessee and the multifamily loans in various locations?

Matt Salem, CEO

Hey, Tom, it's Matt. I can address that. The main takeaway remains consistent in terms of our targets. We will keep focusing on institutional sponsorship and high-quality real estate, particularly in multifamily, industrial, and student housing. We completed a hotel deal this quarter, which is a smaller but important aspect of our portfolio. Regarding what's different, first, we have established a business in Europe over the past few years and are actively lending there, so we aim to include that in our portfolio for diversification. The property types and sponsors will be similar, but this adds geographic diversity. Secondly, from a business plan standpoint, conditions have become more stable, illustrated by the multifamily deal we executed this January. Prior to the rate increase, we were heavily involved in newly built construction takeout lending to help lease assets. While we will continue with that approach, the recent deal is based on mostly leased assets with some concessions potentially phasing out over time. Our loan primarily gives the sponsor more time to improve rates and enhance revenues, rather than the significant increases in occupancy we saw in previous years. The underlying business plans have evolved. Additionally, in terms of property types, there's ongoing strong demand for financing in the data center sector, which could be a new area for us to consider adding to the portfolio.

Tom Catherwood, Analyst

I appreciate that, Matt. For my last question regarding office loans, we typically discuss the sector quietly. You mentioned in your prepared remarks some recent positive changes in the sector, though they come from a very low base. How are you currently evaluating your office loans, including those in your loan book and the REO assets on your balance sheet?

Matt Salem, CEO

Yes. I believe there are three main areas to focus on. In terms of REO, the initial signs of recovery we are witnessing in the sector are promising. Although it's still early, and patience is necessary, we are observing leasing activity. The real estate we own in both the office and life science sectors is of high quality, which is why we chose to acquire it. Although this came at a cost, we believed these assets would lease over time, and we are now starting to see some tenants re-enter the market. It's just the beginning, but it's a positive sign. Regarding the second aspect of our portfolio, I would point out the three rated office loans. There are noticeably more positive indicators as financing markets have reopened. These office loans are generally long-term, well-leased, and have reasonable leverage. As financing markets continue to improve, we can expect to see increased liquidity in these positions, which is encouraging. As for the Watch List, we still face uncertainties. We have a risk-rated office loan in Minneapolis that requires continued monitoring. We have already made modifications and set aside significant reserves, but we are not fully out of that asset yet. Overall, the situation varies depending on which group we are analyzing.

Tom Catherwood, Analyst

Got it. Appreciate all your thoughts. Thanks, everyone.

Matt Salem, CEO

Thank you.

Operator, Operator

Next question will come from Don Fandetti with Wells Fargo. Please go ahead.

Donald Fandetti, Analyst

Yes, Matt, so it seems like there are some cross-currents in your business. You've got office getting a little bit better, but higher for longer might not be so great for apartments, multifamily, as you think about book value, should investors sort of view this as a more stable environment, maybe a little bit of migration from three to four, but nothing too significant to where you're doing very large reserve builds and eating into that book or is that a reasonable kind of base case over the next 12 months?

Matt Salem, CEO

It's challenging to predict the future. We believe we've mostly addressed what we expect from the portfolio, but we're not finished yet. It's difficult to anticipate what might happen in the coming quarters due to the volatile macro environment, interest rates, and the economy. As we enter this phase, we anticipate greater stability in book value, but it's still hard to project what the next few quarters might bring.

Donald Fandetti, Analyst

Got it. What's your perspective on multifamily within your portfolio? You've experienced a few rate cuts, but it seems there may be fewer moving forward. What feedback are you receiving from borrowers? Are they willing to persevere? Is there still some optimism? Additionally, if you do end up taking back real estate, do you believe you can still realize its value given the liquidity in the multifamily sector?

Matt Salem, CEO

Yes, regarding multifamily, there's a significant amount of liquidity in the capital structure, including senior loans and mezzanine preferred equity, and the demand remains strong. Although the forward curve suggests that values may have decreased slightly, there are mitigating factors. First, spreads have narrowed, which means the cost of capital has decreased somewhat in response to the interest rate hike. Second, we are progressing further along the supply pipeline, which indicates that we are approaching a point where the market may become undersupplied again, impacting future rent projections. Additionally, it seems that the recent rate increase has coincided with stronger market growth, which might lead investors to adjust their expectations for rent growth. Overall, I believe our multifamily portfolio is not very sensitive to rate changes. While we have a few watchlist loans, I don’t view them as particularly rate-sensitive, and our overall portfolio is unlikely to be significantly affected. We still have an equity cushion, and I don't expect this rate change to impact us much. Many borrowers have adjusted their capital structures and repaid loans to aim for lower interest rates, but they may need to be patient longer. I believe that within our portfolio and considering the quality of our borrowers, they will navigate this effectively and reduce leverage over time. However, smaller sponsors may struggle more in this environment, which could lead to increased delinquencies. That said, I don't think values in the multifamily sector have shifted significantly over the past couple of quarters. Thank you.

Operator, Operator

And our next question will come from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi, good morning. Matt, I wanted to follow up on your comments about the Minneapolis office. I know you provided some details about the West Hollywood multi-deal. Regarding the Minneapolis office asset, it appears to have a maturity date in the first half of this year. Can you share any insights on the resolution path there? Do you think it will be integrated into the real estate portfolio, or will it follow a path similar to the San Carlos resolution? How do you see this progressing in the first half of the year?

Matt Salem, CEO

We don't have a clear path defined yet, so we are exploring a few different options. I believe we have some time with this asset because it remains well-leased. The occupancy levels have been similar to previous years. While we have lost some tenants and gained others, it is still relatively well-leased and generating good cash flow. It performs competitively in the market, even though Minneapolis is a challenging market. I'm not exactly sure what the future holds, but the cash flow gives us more options, and we could consider pushing forward to buy ourselves more time.

Stephen Laws, Analyst

Great. Appreciate the color. As you think about originations and use of capital, how do you view additional stock repurchases in the current market, especially given kind of the sell-off year-to-date, I guess, assume that's a quiet period, but how do you think about repurchase activity versus new originations going forward?

Matt Salem, CEO

I believe Patrick did a great job emphasizing that we've consistently bought our stock when we believed it was undervalued, and we will continue to consider that opportunity. However, I also think it's essential to maintain a balance. Our primary business is to invest capital and make loans, so it's crucial for us to ensure we're actively making new loans for various reasons, including vintage exposure, portfolio diversification, and duration. I prefer not to see it as an either/or situation; rather, as we've demonstrated over the past few months, we've adopted a balanced approach.

Stephen Laws, Analyst

Great. Patrick, I have a question for you about CECL. Considering the new loans being made in the current environment with the existing cap rates and underwriting standards, how do you view the appropriate level of reserves for these new originations this year? Should we expect it to be around 75 basis points or 100 basis points? How do we assess the normalized return level as we transition back to a portfolio increasingly based on the current market conditions?

Patrick Mattson, President and COO

It's a good question, Steve. Certainly, as we're originating new loans, just on the margin, I'd expect CECL to go up a bit because it's model-driven for these three rated loans. And the model for a short-duration loan like many of the loans on the book today have a lower CECL than newly originated a five-year loan. So, I would expect that marginally we'd sort of go up. Certainly, that's something that we're going to be evaluating as we're making new loans. And I think part of your question is what's a minimum CECL that should be expected. And I think that's something that we continue to do work around. But I do think at the margin over the course of this year, absent any other movement, we would expect that slightly greater CECL.

Stephen Laws, Analyst

To clarify, that is an absolute number, correct, and it is largely driven by portfolio growth due to new originations, or are you referring to some basis points of the portfolio?

Patrick Mattson, President and COO

A little bit of both. One, because I think from a portfolio growth, there's a growth opportunity here, just where we've got capital and where we're at a leverage level. And then at the margin, putting aside resolutions, clearly, if we resolve some of the 4s and the 5s, we'd expect CECL as a percentage to come down. But as I think about our three-rated assets and think about the percentage of CECL against those, I would expect that to go up not only in nominal dollars, but in percentage terms.

Stephen Laws, Analyst

Okay. Great. That's helpful color. I appreciate that, Patrick. I appreciate your time today. Thanks.

Matt Salem, CEO

Thank you.

Patrick Mattson, President and COO

Thank you.

Operator, Operator

Next question will come from Steve Delaney with Citizens JMP. Please go ahead.

Steve Delaney, Analyst

Thanks. Good morning, everyone. Look, first, we just want to applaud the buyback activity. It's very shareholder-friendly and it's something frankly that it's not always seen among the externally managed companies. Your average price was $11.64, we're down to 14% to about $10.05 now or around $10 range. And so we should assume that you continue to view that regardless of the volume and the leverage, I mean, I assume you still look at buybacks as being a very attractive opportunity, is that correct?

Matt Salem, CEO

Thank you for the questions, Matt. Yes, as I mentioned earlier, we are considering both buybacks and new loans. Like we have in the past, we will take a balanced approach.

Steve Delaney, Analyst

Sure. To that point, Matt, regarding the portfolio, I'm curious about the current level at $5.9 billion. Activity has been somewhat slow over the past year or two, primarily due to credit issues. It peaked at $7.6 billion in early 2023. Considering you have $1.4 billion of equity at the end of 2024, do you have a general number or range in mind for how much you expect the portfolio to grow over the next year?

Patrick Mattson, President and COO

Steve, it's Patrick. I'm happy to take that. So, yes, as we think about the portfolio and think about our target leverage range, this is absent resolution of some of the REO assets because that changes a little bit of that number. But just on the current portfolio, we think that number is in the kind of $6.6 billion to $6.7 billion range.

Steve Delaney, Analyst

Very helpful. Well, thanks for the comments. A lot has been covered and I think I'm good.

Matt Salem, CEO

Thank you, Steve.

Operator, Operator

Next question will come from Rick Shane with JPMorgan. Please go ahead.

Rick Shane, Analyst

Good morning, everyone. There's a lot to discuss, but I have two questions. First, we've observed changes in rates. I'm interested in the implication that this puts some downward pressure on valuations. When we examine the current market transactions, is the sentiment and the market's ability to clear more about the price, or does it depend on buyers and sellers feeling more confident about our position—considering we're nearing the end of the cycle? Are people feeling less anxious about losing money, like having paid $100 million and now having to settle for $50 million, or are they more relaxed about it since we're trading at $50 million and worrying less about it possibly being valued at $40 million next week?

Matt Salem, CEO

Hi, Rick, it's Matt. Thanks for the question. Let me answer it this way and hopefully what you're looking for comes through. Over the last few years, the sellers have played a significant role because many of these assets are fundamentally strong. They are well leased, cash flowing, and facing a valuation issue related to cost of capital. As a result, there haven't been many willing sellers in the market. Larger sellers have primarily been focused on liquidity rather than being forced to sell to repatriate capital. That has driven most of the sales. As we enter the next phase, there's more certainty regarding local values. The bid-offer spread has definitely compressed. The question now is whether existing owners want to hold on a bit longer to wait for lower cost of capital and allow growth in their portfolios, letting supply pipelines in the multifamily sector stabilize and generating larger rent increases. That's how I see it. Additionally, capital structures are becoming short as many acquisitions in '21 and '22 were financed with five-year loans. This leads to a more immediate decision-making process for many. Quarter-over-quarter for the past four or five quarters, we've seen an increase in transaction volumes, which I believe reflects reality setting in, capital structures maturing, and a need for liquidity. I think this trend will continue, and I don't anticipate significant changes in transaction volumes this year. We're in a slow deleveraging process for the industry.

Rick Shane, Analyst

Yes. Thank you, Matt. I know this question may be a bit vague, and I appreciate you addressing it. I said I had one more question, but I’m going to follow up with a second one. Is what you just described the reason for the Minneapolis office loan, which you mentioned is well-leased, and you hinted at possibly extending it? Is it really just allowing time for cash flows to better align if the interest rate environment improves?

Matt Salem, CEO

I see the office market as somewhat distinct. While other sectors have experienced liquidity over the past few years, there hasn't been much interest in selling office properties at current prices; most owners prefer to hold onto them. In my opinion, the office sector had very little to no liquidity. However, we are now beginning to see some liquidity returning to the market. This creates a different dynamic where improvements in interest rates could enhance the value of those assets, and an increasing number of buyers expressing interest in office properties could provide a significant boost. I just don't think the office sector was a liquid asset class in recent years, but we are starting to see movement, particularly with high-quality properties leading the way.

Rick Shane, Analyst

Thank you. I have another question. We usually take a broader perspective on the market. One thing I've noticed is that your three-year loans rarely last the full term. During prosperous times, they typically last around 18 to 24 months, while in tougher times, these loans with terms or extensions of five years can extend to six or seven years. We've experienced significant fluctuations in this pattern over the past few years. You mentioned a repayment in the fourth quarter that was previously anticipated for 2026. I understand that's just one loan and that every situation is unique. Is there any sign that some of the newer loans are starting to show a shift back toward the previous timeline?

Matt Salem, CEO

Yes, I believe there is increased liquidity in the debt markets today compared to the past, which is enabling some of our sponsors to refinance sooner. The new loans we are issuing now are quite robust. They have favorable terms and a reset basis. I agree with your observation that these loans are likely to be on the shorter end. As people look to borrow today, especially for refinancing, they likely prefer shorter terms, perhaps just a couple of years, before they look to bring back capital. This situation arises partly because our sponsors have had a few years to execute their business plans, and now they possess the cash flows necessary to either sell or refinance. We are also considering duration in relation to our ongoing strategy with short-duration loans and the portfolio exposure that it can lead to.

Rick Shane, Analyst

Yes. Okay. Really appreciate it. And sorry for all the questions, but I realize we're sort of at the end of this, and hopefully that's okay. Thank you, guys.

Matt Salem, CEO

Sure. Thank you.

Operator, Operator

Our next question will come from Jason Sabshon with KBW. Please go ahead.

Jason Sabshon, Analyst

Hi, good morning. Could you please give an update on KREF's life science deals and the outlook for leasing and ultimately value in those assets? That's probably the number one area of pushback that we hear, so addressing that would be helpful. And is that where you could see the potential credit migration in the portfolio that you alluded to previously? Thanks.

Matt Salem, CEO

Yes, I'll try to cover some of that without going into too much detail. First of all, we've made progress on the life science segment. We foreclosed on an asset and made a significant modification last quarter that we hope will address some issues. Most of our remaining exposure stems from construction loans, which are high-quality, well-located assets. When I mentioned the green shoots, much of it is related to these types of exposures. We believe tenants are returning to these markets, seeking the best properties, and while our exposure isn't entirely in that realm, it is predominantly focused on quality assets. Our sponsors are enthusiastic about the influx of tenants into the market. I'll stop here without going through each loan.

Jason Sabshon, Analyst

Great. Thank you. And on the multifamily watchlist assets, it would be helpful to hear about what the issues there are, is it basis, rent, supply or something else? Thanks.

Matt Salem, CEO

Yes, it partly depends on the specific asset. Some are in supply-driven markets, which has affected occupancy and certainly rental levels. Our West Hollywood multifamily property is different; it was acquired or financed at the peak of the market. This presents more of a value issue from a multifamily standpoint, which is why we're continuing to pursue a condo sell-out there since it was originally designed for that purpose. So, there's a mix depending on which asset we are examining.

Operator, Operator

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

Jack Switala, Investor Relations

Well, great. Thanks, operator, and thanks everyone for joining today. Please feel free to reach out to me or the team here if you have any questions. Take care.

Operator, Operator

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