Earnings Call Transcript - KREF Q2 2022

Operator, Operator

Good morning and welcome to the KKR Real Estate Finance Trust Inc. Second Quarter 2022 Financial Results Conference call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jack Switala. Please, go ahead.

Jack Switala, President

Great. Thanks, Operator. Welcome to the KKR Real Estate Finance Trust earnings call for the second quarter of 2022. 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 would like to remind everyone that we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in our earnings release and in the supplementary presentation, both of which are available on the Investor Relations portion of our website. This call will also contain certain forward-looking statements which do not guarantee future events or performance. Please refer to our most recently filed 10-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 second quarter of 2022, we reported GAAP net income of $19.4 million or $0.28 per diluted share. Distributable earnings this quarter were $33.1 million or $0.48 per share, covering our $0.43 per share Q2 dividend by over 1.1 times on a per share basis. Book value per share as of June 30th, 2022 was $19.36, a decline of less than 1% quarter over quarter, which includes the cumulative CECL impact of $0.49 per share. Increases in our CECL reserves impact to book value this quarter were partially offset by the one million shares we repurchased, which generated $0.03 in book value accretion. Finally, in early June, we paid a cash dividend of $0.43 per common share with respect to the second quarter. Based on yesterday's closing price, the dividend reflects an annualized yield of 9.2%. With that, I would now like to turn the call over to Matt.

Matt Salem, CEO

Thanks, Jack. Good morning, everyone. Thank you for joining us today. KREF is in a strong position to navigate this economic environment of higher inflation and quantitative tightening. Our portfolio is comprised primarily of first mortgage loans, secured by Class A real estate owned by institutional sponsors and located in growth markets. The favorable lending market we discussed in our first quarter call continued into this quarter and we are seeing real estate equity values begin to decline from this higher cost of capital and lower market leverage. Our strong second quarter loan originations of over $1 billion demonstrated our conservative investment selection, with 100% of our activity in multifamily or industrial property types and a low weighted average loan value of 63%. Multifamily and industrial loans now represent nearly 60% of the portfolio as of the second quarter. While we believe this is an attractive market opportunity, as is our DNA, we are currently operating the company at higher levels of liquidity and lower leverage. Since January, we have been proactive and intentional about increasing our equity capital, liquidity, and non-mark-to-market financing facilities. Notably, we have raised over $187 million of common equity and $150 million of preferred equity at an attractive fixed-for-life coupon of 6.5% and increased our revolver by $275 million, while extending its term to a new five years. One of the challenges in this market is securing senior financing. Our ability to leverage the broader KKR relationships and Capital Markets team has enabled us to add approximately $1.5 billion of non-mark-to-market financing capacity including $450 million this quarter. We have many avenues for financing and have historically accessed the CRE CLO market on an opportunistic basis. This diversified approach to financing our portfolio is a strong differentiator in the current market environment. This quarter we had the opportunity to provide a $500 million loan on a cross-portfolio of high-quality, well-leased industrial properties with 97% occupancy located primarily in strong California markets with institutional sponsorship. The properties have embedded mark-to-market upside across existing leases as they expire. In a more stable market, the loan would have likely been securitized in a single asset, single borrower CMBS transaction. But that market is not fully functioning. Our focus on larger loans to institutional sponsors left us well positioned to step in opportunistically. KREF, using its first-in-the-waterfall position, invested 50% for approximately $250 million. Our ability to split loans allows us to originate large loans to high-quality sponsors with favorable competitive dynamics and enables us to finance these loans more attractively while creating diversification benefits within our portfolio. In the second quarter, we received $444 million in loan repayments. Given Q2's strong origination volumes and modest repayments, we grew the funded portfolio by $633 million. In the near term, we intend to continue to operate at a lower leverage with enhanced liquidity, so we anticipate matching new originations with repayments. Finally, I'm also pleased to state that KREF's distributable earnings are now directly correlated to and poised to further benefit from short-term interest rate increases. A 150-basis-point increase in short-term rates since June 30th would represent a $0.30 a share increase in distributable earnings on today's portfolio on an annualized basis. As a reminder, base rates have already increased by approximately 50 basis points. With that, I'll turn the call over to Patrick.

Patrick Mattson, President and COO

Thank you, Matt. Good morning, everyone. I'll focus today on our efforts on the capital and liquidity front and provide a brief update around our watch list. This quarter, with the help of our partners in KKR Capital Markets, we continued to successfully increase our non-mark-to-market financing capacity, which sits at 77% of our outstanding secured financing as of quarter end. Specifically, we entered into a new $350 million term lending agreement and a new $100 million asset-specific financing facility. Both of these facilities provide matched term asset-based financing on a non-mark-to-market basis and allow us to match our recent equity growth with new liabilities. Equally important, these facilities also give us access to attractively priced financing at a time when spreads in the CRE CLO market have increased significantly with corresponding impacts being felt in the broader repo financing markets. In addition, our two existing CLOs with over 12 and 18 months of remaining recycling respectively provide us with a fixed cost of funds to continue to pursue high-quality assets as we receive repayments in each of these previously issued managed transactions. This quarter, $123 million of our repayments were in the CLOs. In terms of equity capital, this was an active quarter. In early June, we completed our largest follow-on equity offering to date. Seven million shares were offered consisting of 2.75 million primary shares and 4.25 million secondary shares from our manager KKR. We expect the offering allowed KKR to reach its anticipated long-term hold position of 10 million shares or approximately 14% of KREF shares outstanding today. We believe this is the highest ownership percentage held by a manager in the mortgage REIT sector and demonstrates continued meaningful alignment between KKR and KREF. In the middle of June, the broader equity markets declined in response to the May CPI print and the corresponding read-through to more significant rate hikes from the Fed. With commercial mortgage rates impacted and KREF trading below book value, we began open market share repurchases to take advantage of the attractive price. Beginning of June this year and subsequent to quarter end, we repurchased approximately 1.4 million shares at a weighted average price per share of $17.32 for a total of $25.1 million. The share repurchases have been accretive to book value per share by over $0.04, of which approximately $0.03 was recognized in Q2. I would also highlight that KREF was one of the first in the space to implement share repurchases at the onset of COVID. For example, back in the first quarter of 2020, we repurchased around $19 million in stock. In times where we feel there's been a dislocation and our shares are undervalued, we've been proactive in a meaningful way on the repurchase front and feel that we have been best-in-class on that front. As Matt mentioned, we were operating at the low end of our target leverage with a total leverage ratio of 3.5 times as of quarter end. We expect to keep leverage in the mid-3s in this market environment and we look for opportunities to deploy capital. Our liquidity position remains very strong and record liquidity exceeding $790 million as of quarter end, which included over $118 million of cash and $610 million in undrawn corporate revolver capacity. In addition, unencumbered senior loan assets grew to $416 million at the end of Q2. I also want to provide an update on our watch list. The current portfolio has a weighted average risk rating of 3.0 on a five-point scale relative to 2.9 in Q1, driven primarily by the payoff of a large one-rated loan coupled with our new originations. Today, 96% of our loans are risk rated three or better. Quarter-over-quarter, our watch list exposure has decreased by a net $37 million on a principal basis. Two Philadelphia office loans remain on the watch list. Both are performing with in-place occupancy and strong sponsors. But these loans remain on the watch list to reflect softer office leasing velocity within the Philadelphia MSA. Regarding our New York condo inventory loan, three residential units remained at quarter end, and subsequent to quarter end one additional unit sold. Recent sales for the units have been made well in excess of our basis. And as such, we have upgraded the outstanding loan to a three rating, removing it from the watch list. In summary, KREF finished the quarter with a record $7.9 billion total funded portfolio, which has grown by approximately 40% on a year-over-year basis. We originated 11 senior loans in Q2 for over $1 billion and grew the funded portfolio by $633 million. We completed our largest follow-on equity offering to date for approximately $137 million in proceeds to both KREF and our manager KKR, added two non-mark-to-market financing facilities, and upsized our revolving credit facility to a total of $610 million. Lastly, we completed accretive share repurchases in June and July for approximately $25 million. Thank you for joining us today. Now we're happy to take your questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. And the first question will come from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi. Good morning. Strong origination quarter, and Matt, I think in your prepared remarks you talked about attractive lending opportunities. Looking at the 2Q originations, it looks like lower LTVs in June than maybe in April. Can you talk about how the markets changed over the last three to six months? What you're looking for now whether that's wider spreads, lower attachment points, other covenants? And talk about the competitive landscape and what that enables you to do in this market.

Matt Salem, CEO

Thank you for the question, Steve. I appreciate your interest. To highlight, the market is continuously evolving in terms of opportunities and the lending environment. At the start of the year, we anticipated a potential tightening in spreads due to rising base rates, but then geopolitical volatility and inflation concerns emerged alongside quantitative tightening and Fed rate hikes. From a leverage perspective, particularly in the multifamily sector—which represents about half of our portfolio—we were around 70% loan-to-value at the start of the year. By March, amid the start of the conflict in Ukraine, it slipped to the mid-60s, and now we're likely in the very low-60s for loan-to-cost ratios. This indicates that leverage has decreased significantly in the lending market. Concurrently, we’ve seen spreads widen, by approximately 75 to 100 basis points. While it's important to note that not all leverage opportunities in the market are alike, it’s fair to describe this as a lenders' market, with improved terms available. We're optimistic about the market, which remains very appealing. The most notable weaknesses are observed in the larger loan segment, affected by capital market instability and challenges in CMBS execution, and in transitional lending due to the struggles of the CRE CLO market impacting repo providers. Our situation is favorable from an opportunity standpoint, particularly in large loans and transitional lending. Many competitors lacking diversified financing are facing challenges in financing their new originations, while we have successfully expanded our financing options in recent years, allowing us to achieve interesting returns on lower-leverage, higher-quality credit. We're enthusiastic about the current market trends, as reflected in our second-quarter activities. However, we are maintaining a cautious outlook on the overall market environment. Hence, when we refer to operating with lower leverage and higher liquidity, we are not fully committing to all opportunities, given the uncertainties around future Fed actions and interest rate movements. We're aiming to stay at our current leverage levels until we observe more stability, and then we may revert to our historically higher leverage, typically seen in the high-3s, compared to the mid-3s at present. Importantly, our pipeline remains robust, unlike the onset of COVID when the market largely shut down. Presently, there are ample lending opportunities, including ongoing acquisitions and refinancing activities. With weaker capital markets, we see many opportunities shifting to balance sheet lenders. I am confident that we can reinvest as repayments come in, and with more macro stability, we can grow our portfolio through normalized leverage levels within the company.

Stephen Laws, Analyst

Thanks, Matt. Helpful comments and your answer covered my follow-up question. Appreciate it.

Operator, Operator

And the next question will come from Jade Rahmani with KBW. Please go ahead.

Jade Rahmani, Analyst

Thank you very much. Looking across the yield curve, the 10-year in particular has declined notably of late. How important of a signal is that with respect to the outlook for commercial real estate? Is that a primary driver of the transitional lending market in terms of flow-through impact to loan pricing and securitizations? And so if the 10-year treasury holds in this range, would you expect improvement in spreads in the back half of the year or do you think that there are risk-off reasons driving the 10-year currently?

Matt Salem, CEO

Jade, it's Matt. I'll preface this statement with I'm not a rates trader, but I do think that real estate equity transaction volumes are certainly coming down. I think that's a function of the uncertainty in the market and the higher cost of capital and the impact on valuations. Some of that is just trying to understand what is the final resting place in this rate environment. I think that the long end of the curve, to your point, is pretty meaningful in terms of how real estate is valued and how a lot of it is obviously financed. I do think that having a – if people – if the market can understand where we're going to end up on a 10-year, that can cause more transaction activity to happen and a little bit of a reboot on the equity side and more clarification on values. That being said, to your point, I think this most recent rally is probably more around fears of recession and the impact from quantitative tightening, so not necessarily a good thing. But it is a good thing if we can get some market stability in interest rates so that real estate transaction volume overall can increase and get a little healthier.

Jade Rahmani, Analyst

Thank you very much. You mentioned you expect to match origination volumes to repayments. Is there a range or level of volumes and repayments to think about? Something similar on the repayment side to the second quarter or any other color you could provide there?

Matt Salem, CEO

Yes, we look at our repayments every quarter when we go through our quarterly review. So the primary goal is a credit assessment and a risk rating. But one of the outputs of that exercise is repayments. I will caution you that it is always difficult to predict repayments on these loans. You don't know exactly when they're going to go. Given that we have larger loans, whether it repays one month versus another can throw off some of the quarterly numbers. If we look out over the course of the year, I think we're predicting repayments in the context of what we received this quarter on a quarterly basis. So I think we're looking at roughly that US$400 million to US$500 million a quarter of repayments. But again, that can kind of be chunky and a lot of it depends on how this market environment evolves and whether you see a little bit more stability. Clearly, that will lead to more repayments as well.

Jade Rahmani, Analyst

Thanks. I have a few more but I'll get back in the queue. Appreciate it.

Matt Salem, CEO

Thanks, Jade.

Operator, Operator

The next question will be from Don Fandetti with Wells Fargo. Please go ahead.

Don Fandetti, Analyst

Hi. Looks like the pretty large provision in the quarter took the allowance up to maybe around 42 basis points. Can you talk about what you're thinking on the provision going forward as that allowance would rise? And then secondly, can you provide any updated thoughts on the office market in terms of your appetite there?

Kendra Decious, CFO

Sure. Hi, Don, this is Kendra. I'll respond to your first question on CECL. As you noted, we increased our CECL reserve to $34 million at the end of the quarter, which represents about 46 basis points of the principal balance. CECL is inherently challenging to predict. We rely on a third-party model and refresh our historical loss rates each quarter. This process is largely driven by quarter-end dynamics. As Matt mentioned earlier, we conduct our own internal loan reviews and obtain updated historical loss data from third-party database providers. Our approach is significantly influenced by the macroeconomic assumptions at the time, which include changing perspectives on recession, unemployment, and Federal Reserve policy. We have consistently maintained a conservative macro assumption, but I cannot specify an exact number or percentage for future expectations. If the economic outlook worsens, it will likely lead to an increase. Conversely, if it stabilizes, as seen in recent quarters, it will probably remain at this level.

Don Fandetti, Analyst

Okay. And the office market?

Matt Salem, CEO

Yes. Hey, Don, it's Matt. Thank you again for the question. On the office market, specifically, as we're positioned at KREF, our focus, as you can see in our originations this quarter, is really on where we're seeing the most growth and the most identifiable growth. And there's a market where, like I mentioned, it's a lenders' market and you can really focus on the easiest loans to underwrite and properties located in the best market. So that's why we've been really focused on industrial and multi-family, I would put life science in that category as well in terms of the demand that we're seeing. So we're really focused on those major growth areas. In terms of office, I don't think our views have changed from the last quarter. I think there's generally a consensus. If you have a quality asset, if you have a Class A asset, certainly in our portfolio, we're seeing momentum and leasing, and then I'd say there's a little bit broader range of positive activity when you get into the growth markets. So certainly in some of the southeast markets you're seeing that carried through beyond just Class A and potentially into some of the Class B space as well. And then when you get into some of the markets that don't have that same growth projections or demographic trends, the Class B segment of the market becomes pretty challenged.

Operator, Operator

Thank you. Our next question will be from Eric Hagen with BTIG. Please go ahead.

Eric Hagen, Analyst

Hey, thanks. Good morning. So, as we look at the LTVs in the portfolio and the credit coverage more generally, is there a debt service coverage ratio that one can think about for the overall portfolio either currently or on a fully-stabilized basis? And then maybe for the origination of the refi loan on the industrial assets in California over the last quarter, can you talk some more about the use of proceeds in the refi? Like did the sponsor cash out any equity from the capital structure? And to that point maybe you can just talk about the attractiveness of loan growth at the expense of more leverage at the sponsor level. Thanks.

Patrick Mattson, President and COO

Eric, good morning, it's Patrick. I'll take the first question. Thanks for asking that. So in terms of coverage and LTV, I think, as Matt indicated, we're definitely seeing leverage come down in the market and specifically on the loans that we're quoting. You can even see a little bit of that. It's hard to read too much into the data set, I guess, when you're talking about a handful of loans each month. Certainly, the leverage in June was lower than the leverage on the loans that we closed in April. In terms of coverage, we're certainly underwriting to an exit-stabilized level. We think about probably debt yield first and foremost, but can translate that into a debt service coverage ratio. Obviously, a lot of the loans, as we're initially making them, are transitional and are not at a one-time coverage, and so those loans are structured with upfront reserves and ongoing reserves to mitigate that shortfall. But when we think about exit, we're certainly thinking about debt yields in this environment that probably are a touch higher than where we are. We want to underwrite to a cushion relative to where we think the exit cap rates are. With some uncertainty on the takeout and uncertainty on what that ultimate exit cap rate is I would say we're erring toward the side of being a bit more conservative and so slightly higher debt yields. We're thinking about debt yields that are in 6%, 7%-plus context. Again, not a crystal ball on rates, but given where we expect rates, we feel like coverage is certainly adequate at those takeout levels.

Eric Hagen, Analyst

That was really helpful. My second question was around the origination of the refi loan on the industrial asset in California and the use of proceeds and the capital structure there. Thanks.

Matt Salem, CEO

Yes. It was basically a financing to take it off an acquisition facility, so almost like a recapitalization that was just occurring going from short-term financing obviously to our bridge loan there. Again, I think the opportunity set was really driven by how expensive the capital markets are today and the single asset single borrower CMBS market in particular. So, in terms of leverage, we're at around mid-60s leverage on that portfolio and the value there is not a big cash out to the sponsor in this particular case. That being said, just given the run-up in values and the tremendous demand that we see for industrial space, we certainly have done loans in the past where you are providing cash back to the sponsors on these really high-quality markets in the industrial segment of the market.

Eric Hagen, Analyst

That's helpful. I appreciate it, guys. Thanks.

Matt Salem, CEO

Yes, thank you.

Operator, Operator

And the next question is from Rick Shane with JPMorgan. Please go ahead.

Rick Shane, Analyst

Hey guys. One pretty specific question and then one more general question. When we look at the LTV distribution, there's a tick up from 7% in the 75% LTV bucket to 10% and it looks like it was driven by a pickup in a Minneapolis loan from 69% to 77%. The balance didn't increase. The loan has a maturity of less than half a year and its category 2. So, it looks like a good credit. I just want to make sure we understand what's going on here because in some ways that LTV description doesn't match with how you guys feel about the credit quality and I suspect that there's something there that we want to understand.

Patrick Mattson, President and COO

Hey Rick, it's Patrick. I'll take the question. I think the point I would highlight here, just the way we look at the LTVs. When we close the loan, we've got an initial balance and we have an as-is value. That's typically the LTV that we're going to show for the life of the loan. Obviously, these are transitional loans. We expect as capital is being put into these assets as they're leasing up that the value is improving. And so they should start to migrate toward a stabilized value. We don't, in fact, then adjust our LTV lower to reflect what we think is probably an improved asset at that point. We keep with the static LTV that we initially had. The only exception to that is if we do a subsequent new appraisal. For example, we're contributing the loan to a CLO, and we have a stale appraisal, then at that point, we'll update the LTV for the current balance and the new as-is value. What you're really seeing is just the reflection of a stale LTV number, and that's why you might have a disconnect between what we're thinking about as a real-world value and what the legacy LTV was.

Rick Shane, Analyst

So, essentially what you're saying is that, that loan was reappraised during the second quarter presumably as you're approaching maturity, but I'm also assuming that that Level two rating reflects conversations with the sponsor and visibility on a strong exit because otherwise it wouldn't be a two?

Patrick Mattson, President and COO

It's a combination of expectation for exit for takeout and then just performance of the loan. Clearly, sponsorship conversations play a part of that, but a lot of it's to do with how our own underwriting of the asset and view of value.

Rick Shane, Analyst

Got it. Okay. And that actually dovetails into the more general question that I had alluded to, which is that again we can sit here and look at all of these numbers on a page, but what we've learned over the years is that each one of these loans is idiosyncratic and that LTV and geo in theory means something, but it doesn't in the real world based upon each sponsor's priorities and liquidity. When you are speaking with sponsors right now, how do you feel about their liquidity positions, their ability to hold on to properties during this period of transition and their commitments to do that?

Matt Salem, CEO

I can jump in on that one. It's Matt. I would say we feel very good about our existing portfolio, especially as it relates to the sponsorship. Historically, that's probably been our highest bar and one of the distinguishing features, or factors within our portfolio and how we make credit decisions. The vast majority of our sponsors are institutional, with a lot of financial wherewithal to carry these properties. We're in segments of the market where there's a pretty strong outlook for real estate. We're in this world now where we're thinking about real estate values because the cost of capital has gone up and because there's uncertainty in the economic environment. However, if you look on the ground and a lot of the portfolio that we have, you're seeing really big rental increases and very strong performance and these markets are structurally full. So, I think that our sponsors are very sophisticated and have a lot of financial wherewithal to carry this through. But a large part, they're in the right sectors and they like the future in terms of the performance of the individual assets that they own.

Rick Shane, Analyst

Thank you, guys. Great. I will say, I really appreciate the way you guys disclose the matched remaining term. It's very helpful, particularly as we're in a period of greater uncertainty for everybody to understand the portfolio, so thanks.

Matt Salem, CEO

Thanks, Rick.

Operator, Operator

Your next question is from Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney, Analyst

Good morning, everyone, and thanks for taking the question. I wanted to go back to loan pricing briefly. Chris found the table on your 11 new loans in the 10-Q and we're seeing 2.7% to 3% type of pricing over LIBOR. And Matt, I want to try to reconcile that to your comment that credit spreads have blown out 75 to 100 basis points. Should we – when we think about the first quarter, should we consider that the commitments on those loans and the final term sheets may have been done as early as the fourth quarter or early first quarter before we got all the rate volatility? And just to tie it in: so you only have to answer one; as we look into the second quarter, and the third quarter should we expect your loan spreads, even on these very high-quality assets, to move higher? Thank you.

Kendra Decious, CFO

Thank you for the question. Steve, I appreciate your observation. There are a few factors to consider. First, it’s about timing. Our loan closing processes typically take six to eight weeks, meaning many deals closed in the second quarter were actually finalized based on first quarter term sheets. Additionally, while the spreads might seem tight compared to today’s market, they were also financed at tighter spreads, making them still beneficial from a return on equity perspective. We are aligned on that front. Generally, these loans are financed in the mid-100s range, which is quite favorable. Secondly, we've shifted our focus towards more stabilized loans. Even when lending to portfolios that could tap into the CMBS market, these tend to consist of more stabilized assets outside of the CRE CLO space. This shift is evident in our attention to occupancy and cash flow, though it might not fully reflect in the loan-to-value ratios. We're taking a more conservative approach within the transitional loan segment, favoring more stabilized loans than we have historically. Finally, it's important to note that the new loans we originate will reflect the current market spreads, which are significantly wider than what we experienced in the first quarter.

Steve Delaney, Analyst

Great. Based on the comments regarding your capacity within your facilities, revolver, and reinvestment in the CLOs, it seems you will aim to increase leverage and grow the portfolio in the second half of this year. However, it is clear that the CLO market isn't currently supportive of that growth. Can I assume that you will continue to pursue loan portfolio growth over the next couple of quarters, regardless of the situation in the CLO new issue market?

Matt Salem, CEO

Yes. We do not feel obligated to the CRE CLO market; we view it as an opportunity when it arises and can be quite beneficial. When the conditions are right, we will issue a CRE CLO, as we appreciate several of its features, including its term financing and reinvestment period. Nevertheless, issuing a CRE CLO has never been our main strategy, and we operated for several years before doing so. We prefer to create customized non-mark-to-market credit facilities for our portfolio. This approach aligns with our business model, as we deal with larger loans that do not fit within the diversified CRE CLO framework, which requires us to explore other options. Additionally, this strategy often involves high-quality real estate and strong sponsorship, attracting many financial intermediaries to take part in senior origination. Regarding our portfolio growth, despite favorable market conditions and access to senior financing, we plan to maintain our current portfolio size until we see greater stability in the broader market and the Fed completes more of its tightening measures. We aim to manage the company with a strong liquidity position, currently at record levels, while keeping leverage low. If the macroeconomic situation begins to improve, we will certainly look to capitalize on attractive opportunities. In the short term, we will primarily be recycling capital from repayments.

Steve Delaney, Analyst

Got it. Well thank you. Very helpful comments. Thanks.

Matt Salem, CEO

Thanks, Steve.

Operator, Operator

The next question is a follow-up question from Jade Rahmani from KBW. Please go ahead.

Jade Rahmani, Analyst

Thanks. On the new deals you're currently looking at, what do you see as the incremental ROEs?

Matt Salem, CEO

Currently, I would say that if we were previously considering a market offering returns in the 11% to 13% range, today's gross ROE IRR reflects a difference of about 200 basis points, indicating low-teens returns.

Jade Rahmani, Analyst

Thanks very much. In terms of the outlook for transaction volumes, it seems likely there won't be many CRE CLOs issued. Do you expect that development to cause spread tightening on the funding cost side in the back half of the year?

Matt Salem, CEO

Sorry Jade, just to make sure, I understood your question. The lack of CRE CLOs will just cause more demand in the market and cause spreads to tighten?

Jade Rahmani, Analyst

Yes, as well as securitization issues. A relative reduction in securitization issuance should potentially allow for the supply-demand dynamic between those bonds to improve, thereby potentially leading to spread tightening.

Matt Salem, CEO

I believe that people are inclined to invest capital over time. If supply is limited, the market will naturally tighten. In some ways, I see it the other way around; spreads tend to tighten when the capital market is healthy. What you mentioned is the initial phase: when there's a lack of activity, it leads to pent-up demand, and the market tightens to a point where it becomes feasible for issuers to enter. I get that. However, significant spread tightening typically occurs when the market is robust, active, and supported by substantial capital market activity. While what you're suggesting may initiate the process, sustained and consistent spread tightening will require a considerable amount of transaction activity and multiple CRE CLOs. I believe we are seeing some initial movement on the CMBS front and a bit on the single asset, single borrower side. This segment of the market is quite transparent and among the more liquid, especially in floating rates. So, my expectation is that this will be the starting point, and despite all markets remaining operational, they are currently expensive. Once we witness a resurgence of activity, that's when we can anticipate more significant spread tightening.

Jade Rahmani, Analyst

Thank you.

Matt Salem, CEO

Thanks, Jade.

Operator, Operator

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, President

Great. Thanks everyone for joining the call this morning. Please reach out to me or the team here if you have any questions. Take care.

Operator, Operator

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