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Rating Action: Moody's assigns first-time Ba2 backed senior secured rating to KKR Real Estate Finance Trust's Term Loan B; outlook stable
Global Credit Research - 27 Jul 2020
New York, July 27, 2020 -- Moody's Investors Service, ("Moody's") has assigned a first-time Ba3 corporate family rating to KKR Real Estate Finance Trust Inc. (KREF) and a backed Ba2 rating to the company's senior secured term loan B, issued by subsidiary KREF Holdings X LLC. The outlook for both entities is stable.
The rapid and widening pandemic and corresponding deterioration in the global and US economic outlooks are leading to significant declines in commercial activity, eroding the financial strength of a wide swath of enterprises, including commercial real estate owners and operators, the subject of KREF's lending activities. As a result, Moody's expects deterioration in asset quality, profitability and capital in 2020 across the non-bank commercial real estate lending sector.
KREF's Ba3 corporate family rating reflects the company's history of profitable operating performance, the high quality composition of its lending portfolio, its effective liquidity and capital management, and the strength of its competitive positioning resulting from its affiliation with KKR & Co. Inc. (KKR). Rating constraints include KREF's short six-year operating history relative to rated peers and its high reliance on secured funding that encumbers its earning assets.
KREF, which commenced operations in 2014, is externally managed by KKR Real Estate Finance Manager LLC, a subsidiary of KKR, a leading global investment firm with $207 billion of assets under management as of 31 March 2020, including over $10 billion through its real estate investing platforms. The affiliation with KKR provides KREF with sector knowledge, access to sponsor and investor relationships, expertise in underwriting and risk management, and access to funding sources that belie KREF's operating scale. Additionally, KKR's ownership interest in KREF of approximately 35% is a strong signal of aligned interests.
KREF's high quality loan portfolio is oriented towards senior secured loans on multifamily and office properties (81% of the portfolio at 30 June 2020) in large metropolitan areas with diverse economies. KREF's exposure to the hospitality and retail sectors, hard hit by the coronavirus pandemic, is a lower percentage of its total investments (8% combined) than every Moody's-rated non-bank commercial real estate lender peer. Moody's expects that KREF's strong portfolio composition should lessen deterioration in asset quality and performance compared to rated peers as the US economy passes through a period of weakness. KREF's loan portfolio is less granular than certain peers, with an average loan size of $134 million at 30 June 2020, but the company's focus on large, experienced sponsors in major markets contributes to its bias for larger more stable loans, aiding performance stability. KREF's portfolio of about 40 commercial real estate loans had a carrying value of $5.3 billion at 30 June 2020.
KREF's profitability, as measured by return on assets, ranged between 0.8% and 1.75% from 2017 through 2019, lower than rated peers, as the company was in the midst of ramping its capital deployment into real estate loan investments during this period. KREF's returns will likely be pressured under currently weakened economic conditions that negatively affect loan performance, but Moody's expects that the company's earnings volatility will be lower than peers, considering its high quality loan portfolio composition and strong asset quality performance. In the first quarter of 2020, KREF recorded a net loss as the company added reserves in connection with the adoption of the Current Expected Credit Loss (CECL) accounting standard, but preliminarily the company reported profitable operations in the second quarter.
KREF has access to diverse funding sources and a well laddered debt maturity profile. At 30 June 2020, the company had $431.1 million of liquidity, including $285 million of undrawn capacity under its $335 million revolving credit facility, $18.8 million of other committed borrowing availability, and cash of $127.3 million, providing adequate coverage of unfunded lending commitments as well as potential margin call requirements in its repurchase facilities. The company's exposure to margin call features in its funding arrangements was 27% at 30 June 2020, a lower percentage than all Moody's rated commercial real estate lender peers; additionally, margin calls are based exclusively on credit factors rather than market factors. KREF's next debt maturity is in October 2021.
KREF's leverage is moderately higher than peers, but this is reflects the lower risk profile of its loan portfolio and the higher proportion of non-mark-to-market financing in its capital structure. Moody's expects that KREF will maintain debt to equity leverage of less than 4.5x.
Key rating constraints include KREF's relatively short operating history and the high proportion of secured funding in its debt capital structure. Moody's expects that secured debt will continue to be the predominant source of KREF's funding, which requires the company to pledge nearly all earning assets, limiting its access to the unsecured debt markets.
KREF's outlook is stable, reflecting the strength of the company's portfolio composition and its manageable exposure to mark-to-credit provisions in its funding structure that position the company to endure likely deterioration in asset performance and real estate values, profitability and capital position relating to the coronavirus pandemic.
The backed Ba2 long-term rating assigned to the term loan B issued by KREF Holdings X LLC reflects the loan's senior secured position in KREF's overall capital structure, the guarantees provided by the issuer's immediate parent holding company and certain affiliates, as well as the collateral pledge of equity interests in certain KREF asset-owning subsidiaries and other assets. Moody's expects that the collateral provides sufficient coverage of the term loan B to reduce its risk of loss compared to more subordinate forms of debt capital. Proceeds of the term loan B will be used primarily to reduce other KREF indebtedness.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Moody's could upgrade KREF's ratings if the company: 1) reduces its reliance on secured debt financing and increases unencumbered assets; 2) maintains strong asset quality; 3) reduces debt-to-tangible net worth leverage; and 4) demonstrates a further track-record of earnings and profitability that compares well with peers, considering differences in investment strategies.
Moody's could downgrade KREF's ratings if the company: 1) experiences a deterioration in asset quality and profitability exceeding Moody's expectations; 2) increases its leverage (debt/tangible net worth) above 4.5x given the current portfolio mix; 3) materially reduces it liquidity position.
The principal methodology used in these ratings was Finance Companies Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187099. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Mark L. Wasden Senior Vice President Financial Institutions Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Ana Arsov MD-Financial Institutions Financial Institutions Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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