KKR REAL ESTATE FINANCE TRUST INC. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. The historical consolidated financial data below reflects the historical results and financial position of KREF. In addition, this discussion and analysis contains forward-looking statements and involves numerous risks and uncertainties, including those described under Part I, Item 1A. "Risk Factors" in the Form 10-K and under "Cautionary Note Regarding Forward-Looking Statements," and Part II, Item 1A. "Risk Factors" in this Form 10-Q. Actual results may differ materially from those contained in any forward-looking statements.
Overview
Our Company and Our Investment Strategy
We are a real estate finance company that focuses primarily on originating and
acquiring senior loans secured by commercial real estate ("CRE") assets. We are
a Maryland corporation that was formed and commenced operations on October 2,
2014 , and we have elected to qualify as a REIT for U.S. federal income tax
purposes. Our investment strategy is to originate or acquire senior loans
collateralized by institutional-quality CRE assets that are owned and operated
by experienced and well-capitalized sponsors and located in liquid markets with
strong underlying fundamentals. The assets in which we invest include senior
loans, mezzanine loans, preferred equity and commercial mortgage-backed
securities ("CMBS") and other real estate-related securities. Our investment
allocation strategy is influenced by prevailing market conditions at the time we
invest, including interest rate, economic and credit market conditions. In
addition, we may invest in assets other than our target assets in the future, in
each case subject to maintaining our qualification as a REIT for U.S. federal
income tax purposes and our exclusion from registration under the Investment
Company Act. Our investment objective is capital preservation and generating
attractive risk-adjusted returns for our stockholders over the long term,
primarily through dividends.
Our Manager
We are externally managed by our Manager,KKR Real Estate Finance Manager LLC , an indirect subsidiary of KKR & Co. Inc. KKR is a leading global investment firm with an over 40-year history of leadership, innovation, and investment excellence and has committed$400.0 million in equity capital to us. KKR manages multiple alternative asset classes, including private equity, real estate, energy, infrastructure and credit, with strategic manager partnerships that manage hedge funds. Our Manager manages our investments and our day-to-day business and affairs in conformity with our investment guidelines and other policies that are approved and monitored by our board of directors. Our Manager is responsible for, among other matters, (i) the selection, origination or purchase and sale of our portfolio investments, (ii) our financing activities and (iii) providing us with investment advisory services. Our Manager is also responsible for our day-to-day operations and performs (or causes to be performed) such services and activities relating to our investments and business and affairs as may be appropriate. Our investment decisions are approved by an investment committee of our Manager that is comprised of senior investment professionals of KKR, including senior investment professionals of KKR's global real estate group. For a summary of certain terms of the management agreement, see Note 12 to our condensed consolidated financial statements included in this Form 10-Q. 46 --------------------------------------------------------------------------------
Key Financial Measures and Indicators
As a real estate finance company, we believe the key financial measures and indicators for our business are earnings per share, dividends declared, Core Earnings and book value per share.
Earnings (Loss) Per Share and Dividends Declared
The following table sets forth the calculation of basic and diluted net income
(loss) per share and dividends declared per share (amounts in thousands, except
share and per share data):
Three Months Ended
June 30, 2020 March 31, 2020
Net income(A) $ 28,590 $ (35,164)
Weighted-average number of shares of common stock
outstanding
Basic 55,491,937 57,346,726
Diluted 55,504,077 57,346,726
Net income per share, basic $ 0.52 $ (0.61)
Net income per share, diluted $ 0.52 $ (0.61)
Dividends declared per share $ 0.43 $ 0.43
(A) Represents net income attributable to common stockholders.
Core Earnings
We use Core Earnings to evaluate our performance excluding the effects of certain transactions and GAAP adjustments we believe are not necessarily indicative of our current loan activity and operations. Core Earnings is a measure that is not prepared in accordance with GAAP. We define Core Earnings for reporting purposes as net income (loss) attributable to our stockholders or, without duplication, owners of our subsidiaries, computed in accordance with GAAP, including realized losses not otherwise included in GAAP net income (loss) and excluding (i) non-cash equity compensation expense, (ii) depreciation and amortization, (iii) any unrealized gains or losses or other similar non-cash items that are included in net income for the applicable reporting period, regardless of whether such items are included in other comprehensive income or loss, or in net income, and (iv) one-time events pursuant to changes in GAAP and certain material non-cash income or expense items after discussions between our Manager and our board of directors and after approval by a majority of our independent directors. The exclusion of depreciation and amortization from the calculation of Core Earnings only applies to debt investments related to real estate to the extent we foreclose upon the property or properties underlying such debt investments. We believe providing Core Earnings on a supplemental basis to our net income as determined in accordance with GAAP is helpful to stockholders in assessing the overall performance of our business. Although pursuant to the Management Agreement with our Manager, we calculate the incentive compensation and base management fees due to our Manager using Core Earnings before incentive compensation, beginning with the first quarter of 2020, we revised our definition of Core Earnings for reporting purposes to be net of incentive compensation, since we believe this is a more meaningful presentation of the economic performance of our common stock. Core Earnings should not be considered as a substitute for GAAP net income. We caution readers that our methodology for calculating Core Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and as a result, our reported Core Earnings may not be comparable to similar measures presented by other REITs. We also use Core Earnings (before incentive compensation payable to our Manager) to determine the management and incentive compensation we pay our Manager. For its services to KREF, our Manager is entitled to a quarterly management fee equal to the greater of$62,500 or 0.375% of a weighted average adjusted equity and quarterly incentive compensation equal to 20.0% of the excess of (a) the trailing 12-month Core Earnings over (b) 7.0% of the trailing 12-month weighted average adjusted equity ("Hurdle Rate"), less incentive compensation KREF already paid to the Manager with respect to the first three calendar quarters of such trailing 12-month period. The quarterly incentive compensation is calculated and paid in arrears with a three-month lag. 47 -------------------------------------------------------------------------------- The following table provides a reconciliation of GAAP net income attributable to common stockholders to Core Earnings (amounts in thousands, except share and per share data): Three Months Ended June 30, 2020 March 31, 2020 Net Income (Loss) Attributable to Common Stockholders$ 28,590 $ (35,164) Adjustments Non-cash equity compensation expense 1,374 1,607 Unrealized (gains) or losses(A) 973 3,444 Provision for credit losses, net (1,366) 55,274 Mezzanine loan write-off (4,650) - Non-cash convertible notes discount amortization 90 90 Core Earnings$ 25,011 $ 25,251 Weighted average number of shares of common stock outstanding Basic 55,491,937 57,346,726 Diluted(B) 55,504,077 57,432,611 Core Earnings per Diluted Weighted Average Share $
0.45 $ 0.44
(A) Includes$0.2 million non-cash redemption value adjustment of our Special Non-Voting Preferred Stock, and$0.8 million of unrealized mark-to-market adjustment to our RECOP I's underlying CMBS investments for the three months endedJune 30, 2020 . Includes$0.4 million non-cash redemption value adjustment of our Special Non-Voting Preferred Stock and$3.0 million of unrealized mark-to-market adjustment to our RECOP I's underlying CMBS investments for the three months endedMarch 31, 2020 . (B) Includes 12,140 and 85,885 dilutive restricted stock units for the three months endedJune 30, 2020 andMarch 31, 2020 , respectively.
Book Value per Share
We believe that book value per share is helpful to stockholders in evaluating
the growth of our company as we have scaled our equity capital base and continue
to invest in our target assets. The following table calculates our book value
per share of common stock (amounts in thousands, except share and per share
data):
June 30, 2020 December 31, 2019
KKR Real Estate Finance Trust Inc. stockholders'
equity $ 1,030,228 $ 1,122,018
Shares of common stock issued and outstanding at
period end 55,491,405 57,486,583
Book value per share of common stock $ 18.57 $ 19.52
Book value per share as of June 30, 2020 includes the impact of an estimated
CECL credit loss allowance of $64.3 million , or ($1.16 ) per common share, and a
$4.7 million , or ($0.08 ) per common share, write-off on a $5.5 million mezzanine
loan. See Note 2 - Summary of Significant Accounting Policies, to our condensed
consolidated financial statements for the period ended June 30, 2020 for
detailed discussion of allowance for credit losses.
In addition, book value per share includes the impact of a $0.6 million , or
($0.01 ) per common share, non-cash redemption value adjustment to our redeemable
Special Non-Voting Preferred Stock ("SNVPS"), resulting in a cumulative (since
issuance of the SNVPS) decrease of $2.3 million , or ($0.04 ) per common share to
our book value ("SNVPS Cumulative Impact") as of June 30, 2020 . Upon redemption
of the SNVPS, our book value will increase as a result of a one-time gain, thus
substantially eliminating the SNVPS Cumulative Impact on our book value. See
Note 9 - Equity, to our condensed consolidated financial statements, for
detailed discussion of the SNVPS.
During the third quarter of 2020, we expect to recognize a decrease of
approximately $0.2 million to the redemption value of our SNVPS and a
corresponding increase to our book value. The non-cash redemption value
adjustment will increase our third quarter of 2020 Net Income Attributable to
Common Stockholders (in accordance with GAAP) and will be added back to Core
Earnings.
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Our Portfolio
We have established a
Our loan portfolio is 99.9% performing as ofJune 30, 2020 . During the three months endedJune 30, 2020 and the month endingJuly 31, 2020 , we collected 99.8% and 99.8% of interest payments due on our loan portfolio, respectively. During the three months endedJune 30, 2020 , we wrote off$4.7 million on a$5.5 million mezzanine loan against the allowance for credit losses. As ofJune 30, 2020 , the average risk rating of our loan portfolio was 3.1 (Average Risk), weighted by total loan exposure. As ofJune 30, 2020 , 84% of our loans, based on total loan exposure, was risk-rated 3 or lower. As ofJune 30, 2020 , the average loan size in our loan portfolio was$133.9 million and multifamily and office loans comprised 81% of our loan portfolio, while hospitality and retail loans comprised 8% of the portfolio. As we continue to scale our loan portfolio, we expect that our originations will continue to be heavily weighted toward floating-rate loans. As ofJune 30, 2020 , 99.9% of our loans by total loan exposure earned a floating rate of interest and 98% of our portfolio is subject to a LIBOR floor of 0.95% or higher and 79% of our portfolio is subject to a LIBOR floor of 1.5% or higher. We expect the majority of our future investment activity to focus on originating floating-rate senior loans that we finance with our repurchase and other financing facilities, with a secondary focus on originating floating-rate loans for which we syndicate a senior position and retain a subordinated interest for our portfolio. As ofJune 30, 2020 , our portfolio did not contain any legacy assets that were originated prior toOctober 2014 . As ofJune 30, 2020 , all of our investments were located inthe United States . The following charts illustrate the diversification and composition of our loan portfolio, based on type of investment, interest rate, underlying property type, geographic location, vintage and LTV as ofJune 30, 2020 (A): [[Image Removed: kref-20200630_g2.jpg]]
The charts above are based on total assets. Total assets reflect the principal amount of our senior and mezzanine loans.
(A) Excludes CMBS B-Piece investments held through RECOP I, an equity method
investment.
(B) LTV is generally based on the initial loan amount divided by the as-is
appraised value as of the date the loan was originated or by the current
principal amount as of the date of the most recent as-is appraised value.
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The following table details our quarterly loan activity (dollars in thousands):
Three Months Ended
September 30,
June 30, 2020 March 31, 2020 December 31, 2019 2019
Loan originations $ - $ 352,500 $ 764,089 $ 484,000
Loan fundings(A) $ 77,818 $
337,055
(54,419) (179,553) (765,418) (193,470)
Net fundings 23,399 157,502 (145,670) 278,164
PIK interest 926 - - -
Total activity $ 24,325 $ 157,502 $ (145,670) $ 278,164
(A) Includes initial funding of new loans and additional fundings made under
existing loans. Excludes fundings on loan participations sold.
(B) Includes $65.0 million of proceeds from syndication of vertical
participation during the three months ended December 31, 2019 , which did not
qualify for sale accounting for GAAP purposes.
The following table details overall statistics for our loan portfolio as of
Total Loan Exposure(A)
Balance Sheet Total Loan Floating Rate
Portfolio Portfolio Loans Fixed Rate Loans
Number of loans 39 39 38 1
Principal balance $ 5,142,525 $ 5,221,125 $ 5,215,625 $ 5,500
Amortized cost $ 5,113,531 $ 5,192,131 $ 5,191,281 $ 850
Unfunded loan commitments(B) $ 512,011 $ 512,011 $ 512,011 $ -
Weighted-average cash coupon(C) 4.8 % 4.8 % L + 3.0 % 11.0 %
Weighted-average all-in yield(C) 5.1 % 5.1 % L + 3.3 % 11.0 %
Weighted-average maximum maturity
(years)(D) 3.7 3.7 3.7 5.0
LTV(E) 66 % 66 % 66 % 72 %
(A) In certain instances, we finance our loans through the non-recourse sale of
a senior interest that is not included in our condensed consolidated financial
statements. Total loan exposure includes the entire loan we originated and
financed.
(B) Unfunded commitments will primarily be funded to finance property
improvements or lease-related expenditures by the borrowers. These future
commitments will be funded over the term of each loan, subject in certain cases
to an expiration date.
(C) As of June 30, 2020 , 100.0% of floating rate loans by principal balance are
indexed to one-month USD LIBOR. In addition to cash coupon, all-in yield
includes the amortization of deferred origination fees, loan origination costs
and purchase discounts. Cash coupon and all-in yield for the total portfolio
assume applicable floating benchmark rates as of June 30, 2020 . L = the greater
of one-month USD LIBOR; spot rate of 0.16%, and the applicable contractual LIBOR
floor, included in portfolio-wide averages represented as fixed rates. Does not
factor in prepayment fee income that might be earned upon prepayment.
(D) Maximum maturity assumes all extension options are exercised by the
borrower; however, our loans may be repaid prior to such date. As of June 30,
2020 , based on total loan exposure, 44.7% of our loans were subject to yield
maintenance or other prepayment restrictions and 55.3% were open to repayment by
the borrower without penalty.
(E) Loan-to-value ratio ("LTV") is generally based on the initial loan amount
divided by the as-is appraised value as of the date the loan was originated or
by the current principal amount as of the date of the most recent as-is
appraised value.
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The table below sets forth additional information relating to our portfolio as
of June 30, 2020 (dollars in millions):
Current
Committed Principal MaxRemaining Term Loan Per SF / Unit
Investment(H) Investment Date Principal Amount Amount Net Equity(B) Location Property Type Coupon(C)(D) (Years)(C)(E ) / Key LTV(C)(F) Risk Rating
Senior Loans(A)
1 Senior Loan 5/22/2019 $ 386.0 $ 375.1 $ 91.9 Brooklyn, NY Multifamily L + 2.7% 3.9 $437,738 / unit 51 % 3
2 Senior Loan 6/28/2019 340.0 334.6 82.7 Chicago, IL Multifamily L + 2.8 6.0 $418,289 / unit 75 3
3 Senior Loan 6/28/2019 273.5 265.1 65.4 Arlington, VA Multifamily L + 2.5 4.0 $238,843 / unit 70 3
4 Senior Loan 12/20/2018 234.5 194.3 37.0 New York, NY Condo (Residential) L + 3.6 3.5 $1,213 / SF 71 4
5 Senior Loan 5/23/2018 227.3 207.0 36.7 Boston, MA Office L + 2.4 2.9 $447 / SF 68 3
6 Senior Loan 2/6/2020 226.5 176.8 32.7 Plano, TX Office L + 2.7 4.6 $190 / SF 64 3
7 Senior Loan 5/31/2019 216.5 208.5 39.2 Various Multifamily L + 3.5 3.9 $194,882 / unit 74 3
8 Senior Loan 11/13/2017 194.4 189.2 34.7 Minneapolis, MN Office L + 3.8 2.4 $178 / SF 63 2
9 Senior Loan 6/6/2019 186.0 179.5 35.3 Chicago, IL Multifamily L + 2.7 3.9 $364,837 / unit 74 3
10 Senior Loan 8/13/2019 185.0 161.1 34.7 Denver, CO Multifamily L + 2.8 4.2 $271,167 / unit 64 3
11 Senior Loan 11/15/2019 183.3 155.9 39.3 Irvine, CA Office L + 2.9 4.4 $256 / SF 66 3
12 Senior Loan 4/11/2019 182.6 153.9 24.3 Philadelphia, PA Office L + 2.6 3.9 $218 / SF 65 3
13 Senior Loan 12/20/2019 175.5 53.0 11.9 Washington, D.C. Office L + 3.4 4.5 $320 / SF 58 3
14 Senior Loan 9/13/2018 172.0 168.0 29.8 Seattle, WA Office L + 3.8 3.3 $490 / SF 62 3
15 Senior Loan 7/15/2019 170.0 130.7 25.5 Chicago, IL Office L + 3.3 4.1 $126 / SF 59 3
16 Senior Loan 6/19/2018 165.0 157.3 29.6 Philadelphia, PA Office L + 2.5 3.0 $162 / SF 71 3
17 Senior Loan 12/5/2018 163.0 148.0 23.1 New York, NY Multifamily L + 2.6 3.4 $556,391 / unit 67
3
18 Senior Loan 11/9/2018 150.6 140.6 27.8 Fort Lauderdale, FL Hospitality L + 2.9 3.4 $406,239 / key 62 4
19 Senior Loan 10/23/2017 150.0 150.0 37.8 North Bergen, NJ Multifamily L + 3.2 2.4 $468,750 / unit 57 3
20 Senior Loan 12/19/2019 147.0 102.2 25.0 Various Retail L + 2.6 5.1 $76 / SF 55 3
21 Senior Loan 3/29/2019 138.0 137.0 22.1 Boston, MA Multifamily L + 2.7 3.8 $351,282 / unit 63 3
22 Senior Loan 11/7/2018 135.0 131.6 20.9 West Palm Beach, FL Multifamily L + 2.9 3.4 $162,108 / unit 73 3
23 Senior Loan 8/4/2017 131.0 131.0 58.0 New York, NY Condo (Residential) L + 4.7 1.3 $1,841 / SF(I) 53 4
24 Senior Loan 10/26/2015 125.0 125.0 49.9 Portland, OR Retail L + 5.5 0.4 $115 / SF 61 4
25 Senior Loan 2/3/2020 106.0 106.0 21.5 San Diego, CA Multifamily L + 3.3 4.6 $458,874 / unit 71 4
26 Senior Loan 10/15/2019 93.4 69.4 16.9 State College, PA Student Housing L + 2.7 4.4 $54,620 / bed 64 3
27 Senior Loan 9/7/2018 92.3 92.3 16.7 Seattle, WA Multifamily L + 2.6 3.2 $515,571 / unit 76 3
28 Senior Loan 12/11/2019 91.0 91.0 18.9 Los Angeles, CA Multifamily L + 2.8 2.5 $421,220 / unit 72 3
29 Senior Loan 3/29/2018 86.0 86.0 14.4 New York, NY Multifamily L + 2.6 2.8 $462,366 / unit 48 1
30 Senior Loan 3/20/2018 80.7 80.7 14.6 Seattle, WA Office L + 3.6 2.8 $473 / SF 61 3
31 Senior Loan 10/30/2018 77.0 77.0 12.9 Philadelphia, PA Multifamily L + 2.7 3.4 $150,980 / unit 73 3
32 Senior Loan 1/8/2019 76.4 76.4 16.0 Brooklyn, NY Hospitality L + 2.9 3.6 $389,633 / key 69 4
33 Senior Loan 7/21/2017 75.1 66.3 12.2 Queens, NY Industrial L + 3.0 2.1 $116 / SF 64 4
34 Senior Loan 7/24/2018 74.5 73.3 17.0 Atlanta, GA Industrial L + 2.7 3.1 $67 / SF 74 1
35 Senior Loan 12/23/2019 73.9 72.8 11.7 Herndon, VA Multifamily L + 2.5
4.5 $247,700 / unit 72 3
36 Senior Loan 9/12/2019 67.5 67.5 12.3 Austin, TX Multifamily L + 2.5 4.2 $190,678 / unit 75 3
37 Senior Loan 8/9/2019 61.5 61.5 11.2 Atlanta, GA Multifamily L + 3.0 4.2 $170,833 / unit 74 2
Total/Weighted Average
Senior Loans Unlevered $ 5,713.0 $ 5,195.6 $ 1,111.6 L + 3.0% 3.7 66 % 3.1
Mezzanine Loans
1 Mezzanine 1/27/2020 20.0 20.0 19.9 Westbury, NY Multifamily L + 9.0
4.1 $464,135 / unit 66 3
2 Mezzanine(J) 6/19/2015 5.5 5.5 0.9 Various RT 11.0% 5.0 $46 / SF 72 5
Total/Weighted Average Mezzanine Loans Unlevered $ 25.5 $ 25.5 $ 20.8 11.0 4.3 67 % 3.4
CMBS B-Pieces
1 RECOP I(G) 2/13/2017 40.0 35.7 35.7 Various Various 4.8 9.0 58
Total/Weighted Average
CMBS B-Pieces Unlevered $ 40.0 $ 35.7 $ 35.7 4.8% 9.0 58 %
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* Numbers presented may not foot due to rounding.
(A) Our total portfolio represents the current principal amount on senior and
mezzanine loans and net equity in RECOP I, which holds CMBS B-Piece
investments.
(B) Net equity reflects (i) the amortized cost basis of our loans, net of
borrowings; and (ii) the cost basis of our investment in RECOP I.
(C) Weighted average is weighted by current principal amount for our senior and
mezzanine loans and by net equity for our RECOP I CMBS B-Pieces.
(D) L = the greater of one-month USD LIBOR; spot rate of 0.16%, and the
applicable contractual LIBOR floor, included in portfolio-wide averages
represented as fixed rates.
(E) Max remaining term (years) assumes all extension options are exercised, if
applicable.
(F) For senior loans, LTV is based on the initial loan amount divided by the
as-is appraised value as of the date the loan was originated or by the current
principal amount as of the date of the most recent as-is appraised value; for
Senior Loan 4, LTV is based on the initial loan amount divided by the appraised
bulk sale value assuming a condo-conversion and no renovation; for Senior Loan
23, LTV is based on the current principal amount divided by the adjusted
appraised gross sellout value net of sales cost; for mezzanine loans, LTV is
based on the current balance of the whole loan dividend by the as-is appraised
value as of the date the loan was originated; for RECOP I CMBS B-Pieces, LTV is
based on the weighted average LTV of the underlying loan pool at issuance.
(G) Represents our investment in an aggregator vehicle alongside RECOP I that
invests in CMBS B-Pieces. Committed principal represents our total commitment to
the aggregator vehicle whereas current principal represents the current funded
amount.
(H) Senior loans include senior mortgages and similar credit quality
investments, including junior participations in our originated senior loans for
which we have syndicated the senior participations and retained the junior
participations for our portfolio and excludes vertical loan participations.
(I) For Senior Loan 23, Loan per SF of $1,841 is based on the allocated loan
amount of the residential units. Excluding the value of the retail and parking
components of the collateral, the Loan per SF is $2,086 based on allocating the
full amount of the loan to only the residential units.
(J) For Mezzanine Loan 2, Current Principal Amount is gross of $4.7 million
write-off (of amortized cost) during the three months ended June 30, 2020 .
Portfolio Surveillance and Credit Quality
Senior and Mezzanine Loans
Our Manager actively manages our portfolio and assesses the risk of any loan impairment by quarterly evaluating the performance of the underlying property, the valuation of comparable assets as well as the financial wherewithal of the associated borrower. Our loan documents generally give us the right to receive regular property, borrower and guarantor financial statements; approve annual budgets and tenant leases; and enforce loan covenants and remedies. In addition, our Manager evaluates the macroeconomic environment, prevailing real estate fundamentals and micro-market dynamics where the underlying property is located. Through site inspections, local market experts and various data sources, as part of its risk assessment, our Manager monitors criteria such as new supply and tenant demand, market occupancy and rental rate trends, and capitalization rates and valuation trends. We maintain a robust asset management relationship with our borrowers and have utilized these relationships to proactively address the potential impacts of the COVID-19 pandemic on our loans secured by properties experiencing cash flow pressure, most significantly hospitality and retail assets. Some of our borrowers have indicated that due to the impact of the COVID-19 pandemic, they will be unable to timely execute their business plans, have had to temporarily close their businesses, or have experienced other negative business consequences and have requested temporary interest deferral or forbearance, or other modifications of their loans. Accordingly, discussions we have had with our borrowers have addressed potential near-term defensive loan modifications, which could include repurposing of reserves, temporary deferrals of interest, or performance test or covenant waivers on loans collateralized by assets directly impacted by the COVID-19 pandemic, and which would generally be coupled with an additional equity commitment and/or guaranty from sponsors. During the three months endedJune 30, 2020 , we entered into loan modifications on our two hotel loans with a total outstanding principal and net book value of$216.9 million and$209.2 million , respectively. These modifications included, among other changes, incremental capital contributions from the borrowers, repurposing of reserves, and a temporary partial deferral for the coupon as payment-in-kind interest ("PIK Interest") due, which is capitalized, compounded, and added to the outstanding principal balance of the respective loans. These loan modifications were not considered troubled debt restructurings under GAAP. We believe our loan sponsors are generally committed to supporting assets collateralizing our loans through additional equity investments, and that we will benefit from our long-standing core business model of originating senior loans collateralized by large assets in major markets with experienced, well-capitalized institutional sponsors. Our portfolio's low weighted-average LTV(1) of 66% as ofJune 30, 2020 reflects significant equity value that our sponsors are motivated to protect through periods of cyclical disruption. While we believe the principal amounts of our loans are generally adequately protected by underlying collateral value, there is a risk that we will not realize the entire principal value of certain investments. In addition to ongoing asset management, our Manager performs a quarterly review of our portfolio whereby each loan is assigned a risk rating of 1 through 5, from lowest risk to highest risk. Our Manager is responsible for reviewing, assigning and updating the risk ratings for each loan on a quarterly basis. The risk ratings are based on many factors, including, but not
(1) LTV is generally based on the initial loan amount divided by the as-is appraised value as of the date the loan was originated or by the current principal amount as of the date of the most recent as-is appraised value.
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limited to, underlying real estate performance and asset value, values of
comparable properties, durability and quality of property cash flows, sponsor
experience and financial wherewithal, and the existence of a risk-mitigating
loan structure. Additional key considerations include LTVs, debt service
coverage ratios, real estate and credit market dynamics, and risk of default or
principal loss. Based on a five-point scale, our loans are rated "1" through
"5," from less risk to greater risk, which ratings are defined as follows:
1-Very Low Risk-The underlying property performance has surpassed underwritten
expectations, and the sponsor's business plan is generally complete. The
property demonstrates stabilized occupancy and/or rental rates resulting in
strong current cash flow and/or a very low LTV (<65%). At the level of
performance, it is very likely that the underlying loan can be refinanced easily
in the period's prevailing capital market conditions.
2-Low Risk-The underlying property performance has matched or exceeded
underwritten expectations, and the sponsor's business plan may be ahead of
schedule or has achieved some or many of the major milestones from a risk
mitigation perspective. The property has achieved improving occupancy at market
rents, resulting in sufficient current cash flow and/or a low LTV (65%-70%).
Operating trends are favorable, and the underlying loan can be refinanced in
today's prevailing capital market conditions. The sponsor/manager is well
capitalized or has demonstrated a history of success in owning or operating
similar real estate.
3-Average Risk-The underlying property performance is in-line with underwritten
expectations, or the sponsor may be in the early stages of executing its
business plan. Current cash flow supports debt service payments, or there is an
ample interest reserve or loan structure in place to provide the sponsor time to
execute the value-improvement plan. The property exhibits a moderate LTV (<75%).
Loan structure appropriately mitigates additional risks. The sponsor/manager has
a stable credit history and experience owning or operating similar real estate.
4-High Risk/Potential for Loss: A loan that has a risk of realizing a principal
loss. The underlying property performance is behind underwritten expectations,
or the sponsor is behind schedule in executing its business plan. The underlying
market fundamentals may have deteriorated, comparable property valuations may be
declining or property occupancy has been volatile, resulting in current cash
flow that may not support debt service payments. The loan exhibits a high LTV
(>80%), and the loan covenants are unlikely to fully mitigate some risks.
Interest payments may come from an interest reserve or sponsor equity.
5-Impaired/Loss Likely: A loan that has a very high risk of realizing a
principal loss or has otherwise incurred a principal loss. The underlying
property performance is significantly behind underwritten expectations, the
sponsor has failed to execute its business plan and/or the sponsor has missed
interest payments. The market fundamentals have deteriorated, or property
performance has unexpectedly declined or valuations for comparable properties
have declined meaningfully since loan origination. Current cash flow does not
support debt service payments. With the current capital structure, the sponsor
might not be incentivized to protect its equity without a restructuring of the
loan. The loan exhibits a very high LTV (>90%), and default may be imminent.
As of June 30, 2020 , the average risk rating of KREF's portfolio was 3.1
(Average Risk), weighted by total loan exposure, as compared to 2.9 (Average
Risk) as of March 31, 2020 .
(dollars in thousands) June 30, 2020
Total Loan
Risk Rating Number of Loans Net Book Value Exposure(A)(B) Total Loan Exposure %
1 2 $ 159,131 $ 159,348 3.1 %
2 2 249,816 250,695 4.8
3 27 3,845,141 3,966,103 76.0
4 7 796,194 839,479 16.0
5 1 850 5,500 0.1
39 $ 5,051,132 $ 5,221,125 100.0 %
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Total Loan
Risk Rating Number of Loans Net Book Value Exposure(A)(B) Total Loan Exposure %
1 2 $ 157,360 $ 158,074 3.0 %
2 3 288,303 291,268 5.6
3 28 3,855,849 4,001,127 77.0
4 7 722,477 746,330 14.4
5 - - - -
40 $ 5,023,989 $ 5,196,799 100.0 %
(A) Excludes $65.0 million vertical loan syndication as of June 30, 2020 and
March 31, 2020 , respectively.
(B) In certain instances, we finance our loans through the non-recourse sale of
a senior interest that is not included in our condensed consolidated financial
statements. Total loan exposure includes the entire loan we originated and
financed, including $143.6 million of such non-consolidated interests and
excludes $65.0 million vertical loan participation as of June 30, 2020 and
March 31, 2020 , respectively.
CMBS B-Piece Investments
Our Manager has processes and procedures in place to monitor and assess the credit quality of our CMBS B-Piece investments and promote the regular and active management of these investments. This includes reviewing the performance of the real estate assets underlying the loans that collateralize the investments and determining the impact of such performance on the credit and return profile of the investments. Our Manager holds monthly surveillance calls with the special servicer of our CMBS B-Piece investments to monitor the performance of our portfolio and discuss issues associated with the loans underlying our CMBS B-Piece investments. At each meeting, our Manager is provided with a due diligence submission for each loan underlying our CMBS B-Piece investments, which includes both property- and loan-level information. These meetings assist our Manager in monitoring our portfolio, identifying any potential loan issues, determining if a re-underwriting of any loan is warranted and examining the timing and severity of any potential losses or impairments. Valuations for our CMBS B-Piece investments are prepared using inputs from an independent valuation firm and confirmed by our Manager via quotes from two or more broker-dealers that actively make markets in CMBS. As part of the quarterly valuation process, our Manager also reviews pricing indications for comparable CMBS and monitors the credit metrics of the loans that collateralize our CMBS B-Piece investments.
During the three months ended
Portfolio Financing
Our portfolio financing arrangements include term loan financing, term lending agreement, collateralized loan obligations, warehouse facility, asset specific financing, non-consolidated senior interest (collectively "Non-Mark-to-Market Financing Sources"), master repurchase agreements, and loan participations sold. Our Non-Mark-to-Market Financing Sources, which accounted for 73% of our total secured financing (excluding our corporate revolver) as ofJune 30, 2020 , are not subject to credit or capital markets mark-to-market provisions. The remaining 27% of our secured borrowings, which is primarily comprised of three master repurchase agreements, are only subject to credit marks. The Company continues to expand and diversify its financing sources, especially those sources that provide non-mark-to-market financing, reducing our exposure to market volatility. Our Non-Mark-to-Market Financing Sources as ofJune 30, 2020 represented 73% of our portfolio financing based on outstanding principal balance, primarily as a result of our term lending agreement, warehouse facility, asset based financing, term loan facility and collateralized loan obligations. 54
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Table of Contents The following table summarizes our portfolio financing (dollars in thousands):
Portfolio Financing Outstanding Principal
Balance(A)
June 30, 2020 December 31, 2019
Master repurchase agreements $ 1,087,806 $ 1,088,217
Term loan financing 984,851 798,180
Term lending agreement 900,000 870,051
Collateralized loan obligations 810,000 810,000
Warehouse facility 57,616 -
Asset specific financing 82,268 142,268
Non-consolidated senior interests 143,600 143,600
Total portfolio financing $ 4,066,141 $ 3,852,316
(A) Excludes $65.0 million of vertical loan participations sold as of June 30,
2020 and December 31, 2019 , respectively. Such participations did not qualify
for sale accounting under GAAP and therefore were consolidated in our Condensed
Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019 ,
respectively.
Financing Agreements
The following table details our financing agreements (dollars in thousands):
June 30, 2020
Maximum Collateral Borrowings
Facility Size(A) Assets(B) Potential(C) Outstanding Available
Master Repurchase
Agreements
Wells Fargo $ 1,000,000 $ 658,280 $ 474,960 $ 469,259 $ 5,701
Morgan Stanley 600,000 558,140 418,605 418,605 -
Goldman Sachs 400,000 305,770 199,942 199,942 -
Term Loan Facility 1,000,000 1,187,632 994,350 984,851 9,499
Term Lending Agreement
KREF Lending V 900,000 1,126,938 900,000 900,000 -
Warehouse Facility
HSBC 500,000 76,821 57,616 57,616 -
Asset Specific Financing
BMO Facility 300,000 107,348 85,879 82,268 3,611
Revolver 335,000 - 335,000 50,000 285,000
$ 5,035,000 $ 4,020,929 $ 3,466,352 $ 3,162,541 $ 303,811
(A) Maximum facility size represents the largest amount of borrowings available
under a given facility once sufficient collateral assets have been approved by
the lender and pledged by us.
(B) Represents the principal balance of the collateral assets.
(C) Potential borrowings represents the total amount we could draw under each
facility based on collateral already approved and pledged. When undrawn, these
amounts are available to us under the terms of each credit facility.
Master Repurchase Agreements
We utilize master repurchase facilities to finance the origination of senior
loans. After a mortgage asset is identified by us, the lender agrees to advance
a certain percentage of the principal of the mortgage to us in exchange for a
secured interest in the mortgage. We did not have any margin calls on any of our
master repurchase facilities to date.
Repurchase agreements effectively allow us to borrow against loans,
participations and securities that we own in an amount generally equal to
(i) the market value of such loans, participations and/or securities multiplied
by (ii) the applicable advance rate. Under these agreements, we sell our loans,
participations and securities to a counterparty and agree to repurchase the same
loans and securities from the counterparty at a price equal to the original
sales price plus an interest factor. The transaction is treated as a secured
loan from the financial institution for GAAP purposes. During the term of a
repurchase agreement, we receive the principal and interest on the related
loans, participations and securities and pay interest to the lender under the
master repurchase agreement. At any point in time, the amounts and the cost of
our repurchase borrowings will be based upon
55
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the assets being financed-higher risk assets will result in lower advance rates
(i.e., levels of leverage) at higher borrowing costs and vice versa. In
addition, these facilities include various financial covenants and limited
recourse guarantees, including those described below.
Each of our existing master repurchase facilities includes "credit
mark-to-market" features. "Credit mark-to-market" provisions in repurchase
facilities are designed to keep the lenders' credit exposure generally constant
as a percentage of the underlying collateral value of the assets pledged as
security to them. If the credit underlying collateral value decreases, the gross
amount of leverage available to us will be reduced as our assets are
marked-to-market, which would reduce our liquidity. The lender under the
applicable repurchase facility sets the valuation and any revaluation of the
collateral assets in its sole, good faith discretion. As a contractual matter,
the lender has the right to reset the value of the assets at any time based on
then-current market conditions, but the market convention is to reassess
valuations on a monthly, quarterly and annual basis using the financial
information delivered pursuant to the facility documentation regarding the real
property, borrower and guarantor under such underlying loans. Generally, if the
lender determines (subject to certain conditions) that the market value of the
collateral in a repurchase transaction has decreased by more than a defined
minimum amount, the lender may require us to provide additional collateral or
lead to margin calls that may require us to repay all or a portion of the funds
advanced. We closely monitor our liquidity and intend to maintain sufficient
liquidity on our balance sheet in order to meet any margin calls in the event of
any significant decreases in asset values. As of June 30, 2020 and December 31,
2019 , the weighted average haircut under our repurchase agreements was 28.5% (or
26.9% if we had borrowed the maximum amount approved by its repurchase agreement
counterparties as of such dates). In addition, our existing master repurchase
facilities are not entirely term-matched financings and may mature before our
CRE debt investments that represent underlying collateral to those financings.
As we negotiate renewals and extensions of these liabilities, we may experience
lower advance rates and higher pricing under the renewed or extended agreements.
Term Loan Financing
In connection with our efforts to diversify our financing sources, further expand our non-mark-to-market borrowing base and reduce our exposure to market volatility, we entered into a term loan financing agreement inApril 2018 with third party lenders for an initial borrowing capacity of$200.0 million that was increased to$1,000.0 million inOctober 2018 ("Term Loan Facility"). The facility provides us with asset-based financing on a non-mark-to-market basis with matched term up to five years and is non-recourse to the Company. Borrowings under the facility are collateralized by senior loans, held-for-investment, and bear interest equal to one-month LIBOR plus a margin. As ofJune 30, 2020 , the weighted average margin and interest rate on the facility were 1.6% and 1.7%, respectively. The following table summarizes our borrowings under the Term Loan Facility (dollars in thousands): June 30, 2020 Outstanding Term Loan Facility Count Principal Amortized Cost Carrying Value Wtd. Avg. Yield/Cost(A) Guarantee(B) Wtd. Avg. Term(C) Collateral assets 13$ 1,187,632 $ 1,181,365 $ 1,170,979 L + 3.1% n.a. February 2024 Financing provided n.a. 984,851 982,217 982,217 L + 1.9% n.a. February 2024 (A) Floating rate loans and related liabilities are indexed to one-month LIBOR. The Company's net interest rate exposure is in direct proportion to its interest in the net assets indexed to that rate. In addition to cash coupon, yield/cost includes the amortization of deferred origination/financing costs. (B) Financing under the Term Loan Facility is non-recourse to theCompany. (C) The weighted-average term is determined using the maximum maturity date of the corresponding loans, assuming all extension options are exercised by the borrower. Term Lending Agreement InJune 2019 , we entered into a Master Repurchase and Securities Contract Agreement (the "Term Lending Agreement") withMorgan Stanley Mortgage Capital Holdings LLC ("Administrative Agent"), as administrative agent on behalf ofMorgan Stanley Bank, N.A. ("Initial Buyer"), which provides for current and future financings of up to$900.0 million on a non-mark-to-market basis. The Initial Buyer subsequently syndicated a portion of the facility to multiple financial institutions. As ofJune 30, 2020 , the Initial Buyer held 48.9% of the total commitment under the facility. Borrowings under the Term Lending Agreement are collateralized by certain loans, held for investment, and bear interest equal to one-month LIBOR, plus a 1.9% margin. Total outstanding borrowings under the Term Lending Agreement as ofJune 30, 2020 totaled$900.0 million . The Term Lending Agreement has an initial maturity ofJune 2021 , subject to five one-year extension options, which may be exercised by us upon the satisfaction of certain customary conditions and thresholds. 56 -------------------------------------------------------------------------------- Table of Contents Warehouse Facility InMarch 2020 , we entered into a$500.0 million Loan and Security Agreement withHSBC Bank USA, National Association ("HSBC Facility"). The facility, which matures inMarch 2023 , provides warehouse financing on a non-mark-to-market basis with partial recourse to us. Borrowings under the facility are collateralized by certain loans, held for investment, and bear interest equal to one-month LIBOR, plus a margin. As ofJune 30, 2020 , the collateral-based margin was 1.50%. Asset Specific Financing InAugust 2018 , we entered into a$200.0 million loan financing facility withBMO Harris Bank (the "BMO Facility"). InMay 2019 , KREF increased the borrowing capacity to$300.0 million . The facility provides asset-based financing on a non-mark-to-market basis with matched-term up to five years with partial recourse to the Company. As ofJune 30, 2020 , there was$82.3 million outstanding on this facility.
Revolving Credit Agreement
We have a$335.0 million corporate revolving credit facility ("Revolver") administered byMorgan Stanley Senior Funding, Inc. We may use our Revolver as a source of financing, which is designed to provide short-term liquidity to purchase or de-lever loans, pay operating expenses and borrow amounts for general corporate purposes. Borrowings under the Revolver bear interest at a per annum rate equal to the sum of (i) a floating rate index and (ii) a fixed margin. As ofJune 30, 2020 , there was$50.0 million outstanding on this facility. Our Revolver is secured by corporate level guarantees and does not include asset-based collateral.
Collateralized Loan Obligations
InNovember 2018 , we financed a pool of loan participations from our existing loan portfolio through a managed collateralized loan obligation ("CLO" or "KREF 2018-FL1"). The CLO provides us with match-term financing on a non-mark-to-market and non-recourse basis. The CLO has a two-year reinvestment feature that allows principal proceeds of the collateral assets to be reinvested in qualifying replacement assets, subject to the satisfaction of certain conditions set forth in the indenture.
The following table outlines KREF 2018-FL1 collateral assets and respective borrowing (dollars in thousands):
June 30, 2020
Outstanding
Collateralized Loan Obligation Count Principal Amortized Cost Carrying Value Wtd. Avg. Yield/Cost(B)
Wtd. Avg. Term(C)
Collateral assets(A) 21 $ 1,000,000 $ 1,000,000 $ 984,363 L + 2.8% November 2023
Financing provided 1 810,000 806,645 806,645 L + 2.2% June 2036
(A)Excluding $8.0 million cash, collateral assets represent 19.3% of the
principal of the Company's senior loans as of June 30, 2020 . As of June 30,
2020 , 100% of the Company's loans financed through the CLO are floating rate
loans.
(B)Yield on collateral assets is based on cash coupon. Financing cost includes
amortization of deferred financing costs incurred in connection with the CLO.
(C)Loan term represents weighted-average final maturity, assuming extension
options are exercised by the borrower. Repayments of CLO notes are dependent on
timing of related collateral loan asset repayments post reinvestment period. The
term of the CLO notes represents the rated final distribution date.
Loan Participations Sold
In connection with our investments in CRE loans, we finance certain investments
through the syndication of a non-recourse, or limited-recourse, loan
participation to an unaffiliated third party. Our presentation of the senior
loan and related financing involved in the syndication depends upon whether GAAP
recognized the transaction as a sale, though such differences in presentation do
not generally impact our net stockholders' equity or net income aside from
timing differences in the recognition of certain transaction costs.
To the extent that GAAP recognizes a sale resulting from the syndication, we
derecognize the participation in the senior/whole loan that we sold and continue
to carry the retained portion of the loan as an investment. While we do not
generally expect to recognize a material gain or loss on these sales, we would
realize a gain or loss in an amount equal to the difference between the net
proceeds received from the third party purchaser and our carrying value of the
loan participation we sold at time of sale. Furthermore, we recognize interest
income only on the portion of the senior loan that we retain as a result of the
sale.
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To the extent that GAAP does not recognize a sale resulting from the
syndication, we do not derecognize the participation in the senior/whole loan
that we sold. Instead, we recognize a loan participation sold liability in an
amount equal to the principal of the loan participation syndicated less any
unamortized discounts or financing costs resulting from the syndication. We
continue to recognize interest income on the entire senior loan, including the
interest attributable to the loan participation sold, as well as interest
expense on the loan participation sold liability.
The following table details our loan participations sold (dollars in thousands):
June 30, 2020
Principal
Loan Participations Sold Count Balance Amortized Cost Carrying Value Yield/Cost(A) Guarantee Term Total loan 1$ 330,116 $ 328,818 $ 326,573 L + 2.5% n.a. July 2024 Vertical loan participation(B) 1 65,000 64,978 64,978 L + 2.5% n.a. July 2024 (A) Our floating rate loans and related liabilities were indexed to one-month LIBOR. Our net interest rate exposure is in direct proportion to our net assets. (B) During the six months endedJune 30, 2020 , KREF recorded$1.4 million of interest income and$1.4 million of interest expense, respectively, related to the total loan participations sold.
Non-Consolidated Senior Interests
In certain instances, we finance our loans through the non-recourse sale of a
senior loan interest that is not included in our condensed consolidated
financial statements. These non-consolidated senior interests provide structural
leverage for our net investments on a non-mark-to-market, matched-term basis,
which are reflected in the form of mezzanine loans or other subordinate
interests on our balance sheets and in our statements of income.
The following table details the subordinate interests retained on our balance
sheet and the related non-consolidated senior interests (dollars in thousands):
June 30, 2020
Principal
Non-Consolidated Senior Interests Count Balance Carrying Value Yield/Cost(A) Guarantee Term
Total loan 1 $ 179,500 n.a. L + 2.7% n.a. June 2024
Senior participation 1 143,600 n.a. L + 1.6% n.a. June 2024
Subordinate interests retained 35,900
(A) Our floating rate loans and related liabilities were indexed to one-month LIBOR. Our net interest rate exposure is in direct proportion to our net assets.
Convertible Notes
We may issue convertible debt to take advantage of favorable market conditions. InMay 2018 , we issued$143.75 million of 6.125% Convertible Notes due onMay 15, 2023 . The Convertible Notes bear interest at a rate of 6.125% per year, payable semi-annually in arrears onMay 15 andNovember 15 of each year, beginning onNovember 15, 2018 . The Convertible Notes mature onMay 15, 2023 , unless earlier repurchased or converted. Refer to Notes 2 and 6 to our condensed consolidated financial statements for additional discussion of our Convertible Notes. 58
-------------------------------------------------------------------------------- Table of Contents Borrowing Activities
The following tables provide additional information regarding our borrowings (dollars in thousands):
Six Months Ended June 30, 2020
Outstanding Principal Average Daily Amount Maximum Amount Weighted Average
at June 30, 2020 Outstanding(A) Outstanding Daily Interest Rate
Wells Fargo $ 469,259 $ 468,457 $ 469,259 2.5 %
Morgan Stanley 418,605 407,832 418,605 2.7
Goldman Sachs 199,942 215,596 225,266 3.2
Term Loan Facility 984,851 912,918 984,851 2.5
KREF Lending V 900,000 893,595 900,000 2.9
Warehouse Facility 57,616 49,200 57,616 2.0
BMO Facility 82,268 93,147 142,267 2.7
Revolver 50,000 147,940 335,000 2.6
Total/Weighted Average $ 3,162,541 2.7 %
(A) Represents the average for the period the facility was outstanding.
Average Daily Amount Outstanding(A)
Three Months Ended
June 30, 2020 March 31, 2020
Wells Fargo $ 468,461 $ 468,452
Morgan Stanley 413,207 402,457
Goldman Sachs 208,057 223,135
Term Loan Facility 967,050 858,787
KREF Lending V 899,195 887,995
Warehouse Facility 50,156 45,417
BMO Facility 82,267 104,026
Revolver 195,769 100,110
(A) Represents the average for the period the debt was outstanding.
Covenants-Each of our repurchase facilities, Term Lending Agreement, Warehouse Facility and our Revolver contain customary terms and conditions, including, but not limited to, negative covenants relating to restrictions on our operations with respect to our status as a REIT, and financial covenants, such as: •an interest income to interest expense ratio covenant (1.5 to 1.0); •a minimum consolidated tangible net worth covenant (75.0% of the aggregate net cash proceeds of any equity issuances made and any capital contributions received by us andKKR Real Estate Finance Holdings L.P. (our "Operating Partnership") or up to approximately$880.2 million , depending on the agreement; •a cash liquidity covenant (the greater of$10.0 million or 5.0% of our recourse indebtedness); •a total indebtedness covenant (75.0% of our total assets, net of VIE liabilities);
As of
Guarantees-In connection with each master repurchase agreement, ourOperating Partnership has entered into a limited guarantee in favor of each lender, under which ourOperating Partnership guarantees the obligations of the borrower under the respective master repurchase agreement (i) in the case of certain defaults, up to a maximum liability of 25.0% of the then-outstanding repurchase price of the eligible loans, participations or securities, as applicable, or (ii) up to a maximum liability of 100.0% in the case of certain "bad boy" defaults. The borrower in each case is a special purpose subsidiary of the Company. In connection with our Term Lending Agreement, ourOperating Partnership entered into a guarantee in favor ofMorgan Stanley Mortgage Capital Holdings LLC , in its capacity as the Administrative Agent, under which ourOperating Partnership guarantees the obligations of theKREF Lending V LLC under the agreement. The guarantee includes; in the case of certain defaults, up to a maximum liability of 25.0% of the then outstanding aggregate repurchase price under the agreement, and liability to indemnify the Administrative Agent against losses related to "bad boy" acts. In addition, the guarantee includes certain full recourses in the case of bankruptcy of theKREF Lending V LLC . 59
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In connection with our BMO Facility, ourOperating Partnership entered into a guarantee in favor ofBMO Harris Bank, N.A ., in its capacity as the Administrative Agent and Lender, under which ourOperating Partnership guarantees the obligations of the Company's borrower entity, under the agreement. The guarantee includes; in the case of certain defaults, up to a maximum liability of 25.0% of the then current outstanding payment obligations under the agreement, and liability to indemnify the Administrative Agent and Lender against losses related to "bad boy" acts. In addition, the guarantee includes certain full recourse insolvency-related trigger events.
With respect to our Revolver, amounts borrowed are full recourse to certain guarantor wholly-owned subsidiaries of the Company.
In connection with our HSBC Warehouse Facility, ourOperating Partnership entered into a guarantee in favor ofHSBC Bank USA, National Association , in its capacity as the Administrative Agent and Lender, under which ourOperating Partnership guarantees the obligations of the Company's borrower entity, under the agreement. The guarantee includes; in the case of certain defaults, up to a maximum liability of 25.0% of the then current outstanding payment obligations under the agreement, and liability to indemnify the Administrative Agent and Lender against losses related to "bad boy" acts. In addition, the guarantee includes certain full recourse insolvency-related trigger events. 60 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table summarizes the changes in our results of operations for the three and six months endedJune 30, 2020 and 2019 (dollars in thousands, except per share data): For the Three Months Ended June 30, Increase (Decrease) For the Six Months EndedJune 30 , Increase
(Decrease)
2020 2019 Dollars Percentage 2020 2019 Dollars Percentage
Net Interest Income
Interest income $ 67,219 $ 62,944 $ 4,275 6.8 % $ 138,298 $ 127,695 $ 10,603 8.3 %
Interest expense 30,563 37,089 (6,526) (17.6) 69,645 71,931 (2,286) (3.2)
Total net interest income 36,656 25,855 10,801 41.8 68,653 55,764 12,889 23.1
Other Income
Income (loss) from equity
method investments 297 868 (571) (65.8) (1,604) 1,993 (3,597) (180.5)
Change in net assets related
to CMBS consolidated variable
interest entities - (1,551) 1,551 100.0 - (1,209) 1,209 100.0
Other income 196 671 (475) (70.8) 556 1,153 (597) (51.8)
Total other income (loss) 493 (12) 505 4,208.3 (1,048) 1,937 (2,985) (154.1)
Operating Expenses
General and administrative 4,046 2,781 1,265 45.5 7,813 5,142 2,671 51.9
Provision for credit losses,
net (1,366) - (1,366) (100.0) 53,908 - 53,908 100.0
Management fees to affiliate 4,218 4,288 (70) (1.6) 8,517 8,575 (58) (0.7)
Incentive compensation to
affiliate 1,249 1,145 104 9.1 2,855 2,098 757 36.1
Total operating expenses 8,147 8,214 (67) (0.8) 73,093 15,815 57,278 362.2
Income (Loss) Before Income
Taxes, Preferred Dividends and
Redemption Value Adjustment 29,002 17,629 11,373 64.5 (5,488) 41,886 (47,374) (113.1)
Income tax expense 77 280 (203) (72.5) 159 289 (130) (45.0)
Net Income (Loss) 28,925 17,349 11,576 66.7 (5,647) 41,597 (47,244) (113.6)
Preferred Stock Dividends and
Redemption Value Adjustment 335 (32) 367 1,146.9 927 (489) 1,416 289.6
Net Income (Loss) Attributable
to Common Stockholders $ 28,590 $ 17,381 $ 11,209 64.5 % $ (6,574) $ 42,086 $ (48,660) (115.6) %
Net Income (Loss) Per Share of
Common Stock
Basic $ 0.52 $ 0.30 $ 0.22 73.3 % $ (0.12) $ 0.73 $ (0.85) (116.4) %
Diluted $ 0.52 $ 0.30 $ 0.22 73.3 % $ (0.12) $ 0.73 $ (0.85) (116.4) %
Dividends Declared per Share
of Common Stock $ 0.43 $ 0.43 $ - - % $ 0.86 $ 0.86 $ - - %
Net Interest Income
Net interest income increased by $10.8 million and $12.9 million , respectively,
during the three and six months ended June 30, 2020 , compared to the three and
six months ended June 30, 2019 . This increase was primarily due to the increase
in our interest income as a result of continuing capital deployment and the
benefit from attractive in-the-money LIBOR floors (when LIBOR floors exceed spot
LIBOR) during the six months ended June 30, 2020 . The weighted-average principal
balance of our loan portfolio increased by $1.1 billion and $1.2 billion ,
respectively, for the three and six months ended June 30, 2020 , compared to the
corresponding periods in 2019. The increase in interest income was partially
offset by the incremental interest expense incurred from additional borrowings
on our financing facilities to fund loan originations and higher leverage. The
weighted-average principal balance of our borrowings increased by $1.1 billion
and $1.1 billion , respectively, for the three and six months ended June 30,
2020 , compared to the corresponding periods in 2019. In addition, we benefited
from in-the-money LIBOR floors in our loans during the six months ended June 30,
2020 as 98% of our loan portfolio is subject to a LIBOR floor of 0.95% or higher
while 5% of total outstanding financing is subject to a LIBOR floor greater than
0.0%.
61-------------------------------------------------------------------------------- Table of Contents In addition, we recognized$4.5 million and 8.9 million of deferred loan fees and origination discounts accreted into interest income, respectively, during the three and six months endedJune 30, 2020 , as compared to$4.1 million and$10.5 million during the corresponding periods in 2019. During the six months endedJune 30, 2020 , we also recognized a non-recurring exit fee income of$2.8 million .
We also recorded
Other Income
Total other income decreased by$3.0 million during the six months endedJune 30, 2020 , as compared to the six months endedJune 30, 2019 . This decrease was primarily due to a$3.8 million unrealized mark-to-market loss from our RECOP I equity method investment during the six months endedJune 30, 2020 , as compared to a$1.2 million loss on CMBS B-Piece investments during the six months endedJune 30, 2019 .
Operating Expenses
Total operating expenses increased by$57.3 million during the six months endedJune 30, 2020 , as compared to the six months endedJune 30, 2019 . This increase was primarily due to (i) a$53.9 million provision for credit losses in connection with adopting ASU 2016-03 onJanuary 1, 2020 , (ii) a$0.9 million increase in non-cash stock-based compensation expense, (iii) a$0.8 million increase in Manager incentive compensation, and (iv)$1.5 million in non-recurring dead deal costs for the six months endedJune 30, 2020 . We did not have a provision for loan credit losses prior toJanuary 1, 2020 . Upon the adoption of ASU 2016-13 onJanuary 1, 2020 , we recorded a$15.0 million cumulative-effect adjustment to our accumulated deficit. During the six months endedJune 30, 2020 , we recorded an incremental$53.9 million in credit loss provision due to the adverse change in the economic outlook due to the COVID pandemic.
The following table provides additional information regarding total operating expenses (dollars in thousands):
Three Months Ended
June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019
Professional services $ 566 $ 764 $ 765 $ 711 $ 839
Operating and other costs 2,106 1,396 894 953 899
Stock-based compensation 1,374 1,607 1,017 1,040 1,043
Total general and
administrative expenses 4,046 3,767 2,676 2,704 2,781
Provision for credit
losses, net (1,366) 55,274 - - -
Management fees to
affiliate 4,218 4,299 4,280 4,280 4,288
Incentive compensation to
affiliate 1,249 1,606 1,174 - 1,145
Total operating expenses $ 8,147 $ 64,946 $ 8,130 $ 6,984 $ 8,214
COVID-19 Impact
The significant and wide-ranging response of international, federal, state and
local public health and governmental authorities to the COVID-19 pandemic in
regions across the United States and the world, including the imposition of
quarantines, "stay-at-home" orders and similar mandates for many individuals to
substantially restrict daily activities and for many businesses to curtail or
cease normal operations, and the volatile economic, business and financial
market conditions resulting therefrom, are expected to negatively impact our
business, financial performance and operating results in later periods of 2020.
Although we are uncertain of the potential full magnitude or duration of the
business and economic impacts from the unprecedented public health efforts to
contain and combat the spread of COVID-19, we will likely experience material
deterioration in our financial performance and operating results, revenues, cash
flow and/or profitability in one or more of the remaining periods in 2020 (in
addition to the second quarter) compared to the corresponding prior-year periods
and compared to our expectations at the beginning of our 2020 fiscal year.
Further discussion of the potential impacts on our business from the COVID-19
pandemic is provided below in the section entitled "Risk Factors" in Part II,
Item 1A of this Quarterly Report on Form 10-Q.
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Liquidity and Capital Resources
Overview
We have capitalized our business to date primarily through the issuance and sale of our common stock, borrowings from Non-Mark-to-Market Financing Sources(1), borrowings from three master repurchase agreements, and issuance and sale of convertible notes. Our Non-Mark-to Market Financing Sources, which accounted for 73% of our total secured financing (excluding our corporate Revolver) as ofJune 30, 2020 , are not subject to credit or capital markets mark-to-market provisions. The remaining 27% of our secured borrowings, which are comprised of three master repurchase agreements, are only subject to credit marks. We did not receive any margin calls on our master repurchase agreements to date, nor do we expect any at this time. Our primary sources of liquidity include cash on our consolidated balance sheet of$127.3 million , available borrowings under our financing arrangements using existing collateral totaling$18.8 million , cash flows from operations, and$285.0 million available on our corporate revolver. Our corporate revolver is secured by corporate level guarantees and does not include asset-based collateral. We may seek additional sources of liquidity from syndicated financing, other borrowings (including borrowings not related to a specific investment) and future offerings of equity and debt securities. Our primary liquidity needs include our ongoing commitments to repay the principal and interest on our borrowings and pay other financing costs, financing our assets, meeting future funding obligations, making distributions to our stockholders, funding our operations that includes making payments to our Manager in accordance with the management agreement, and other general business needs. We are continuing to monitor the COVID-19 pandemic and its impact on our operating partners, financing sources, borrowers and their tenants, and the economy as a whole. The magnitude and duration of the COVID-19 pandemic, and its impact on our operations and liquidity, are uncertain and continue to evolve inthe United States and globally. To the extent that our operating partners, financing sources, borrower's and their tenants continue to be impacted by the COVID-19 pandemic, or by the other risks disclosed in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K, it would have a material adverse effect on our liquidity and capital resources. To facilitate future offerings of equity, debt and other securities, we have in place an effective shelf registration statement (the "Shelf") with theSEC . The amount of securities that may be issued pursuant to this Shelf is not to exceed$750.0 million . The securities covered by this Shelf include: (i) common stock, (ii) preferred stock, (iii) depository shares, (iv) debt securities, (v) warrants, (vi) subscription rights, (vii) and purchase contracts, and (viii) units. The specifics of any future offerings, along with the use of proceeds of any securities offered, will be described in detail in a prospectus supplement, or other offering material, at the time of any offering. InFebruary 2019 , we entered into an equity distribution agreement with certain sales agents, pursuant to which we may sell, from time to time, up to an aggregate sales price of$100.0 million of our common stock, pursuant to a continuous offering program (the "ATM"), under the shelf. Sales of our common stock made pursuant to the ATM may be made in negotiated transactions or transactions that are deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act. We did not sell any shares of our common stock under the ATM to date. See Notes 4, 5, 6 and 9 to our condensed consolidated financial statements for additional details regarding our secured financing agreements, collateralized loan obligations, convertible notes and stock activity.
(1) Comprised of term loan financing, term lending agreement, collateralized loan obligations, warehouse facility, asset specific financing, and non-consolidated senior interests.
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Table of Contents
Debt-to-Equity Ratio and Total Leverage Ratio
The following table presents our debt-to-equity ratio and total leverage ratio:
June 30, 2020 December 31, 2019
Debt-to-equity ratio(A) 2.1x 1.9x
Total leverage ratio(B) 4.0x 3.5x
(A) Represents (i) total outstanding debt agreements (excluding non-recourse
term loan facility) and convertible notes, less cash to (ii) total permanent
equity, in each case, at period end.
(B) Represents (i) total outstanding debt agreements, convertible notes, loan
participations sold (excluding vertical loan syndications), non-consolidated
senior interests and collateralized loan obligation, less cash to (ii) total
stockholders' equity, in each case, at period end.
Sources of Liquidity
Our primary sources of liquidity include cash and cash equivalents and available
borrowings under our secured financing agreements, inclusive of our Revolver.
Amounts available under these sources as of the date presented are summarized in
the following table (dollars in thousands):
June 30, 2020 December 31, 2019
Cash and cash equivalents(A) $ 127,250 $ 67,619
Available borrowings under master repurchase
agreements 5,701 6,174
Available borrowings under term loan financing
facility 9,499 41,364
Available borrowings under term lending agreement - 15,922
Available borrowings under warehouse facility - -
Available borrowings under asset specific financing 3,611 2,592
Available borrowings under revolving credit agreements 285,000 250,000
$ 431,061 $ 383,671 (A) Includes
In addition to our primary sources of liquidity, we have access to further liquidity through our ATM program and public offerings of debt and equity securities. Our existing loan portfolio also provides us with liquidity as loans are repaid or sold, in whole or in part, and the proceeds from repayment become available for us to invest.
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