KKR Real Estate Finance Trust - Q2 2023

Transcript

Operator (participant)

Good morning, and welcome to the KKR Real Estate Finance Trust Inc. second quarter 2023 financial results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Jack Switala. Please go ahead.

Jack Switala (Director and Head of Investor Relations)

Great. Thanks, operator, welcome to the KKR Real Estate Finance Trust earnings call for the second quarter of 2023. As the operator mentioned, this is Jack Switala. Today, I'm joined on the call by our Chief Executive Officer, Matt Salem, our President and Chief Operating Officer, Patrick Mattson, and our Chief Financial Officer, Kendra Decious. I'd like to remind everyone that we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in our earnings release and in the supplementary presentation, both of which are available on the investor relations portion of our website. This call will also contain certain forward-looking statements which do not guarantee future events or performance. Please refer to our most recently filed 10-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 2023, we reported a GAAP net loss of $25.8 million, or -$0.37 per diluted share, including a CECL provision of $56.3 million or $0.82 per diluted share. Distributable earnings this quarter were $33.1 million or $0.48 per share. Book value per share as of June 30, 2023, was $16.38, a decline of 4.5% quarter-over-quarter. Our CECL allowance increased to $3.30 per share from $2.48 per share last quarter. The increase was primarily due to additional reserves on risk-rated five senior office loans, as well as macroeconomic conditions. In 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 thirteen and a half percent. With that, I'd now like to turn the call over to Matt.

Matt Salem (CEO)

Thanks, Jack. Good morning. Thank you for joining us today. KREF generated another quarter of strong distributable earnings of $0.48 per share relative to our $0.43 per share dividend. Distributable earnings continue to benefit from the higher interest rate environment. While higher interest rates are beneficial from an earnings standpoint, this dynamic has created challenges for commercial real estate, with little capital markets liquidity and declining asset valuations. We anticipate the current dislocation and associated volatility will persist for the foreseeable future. Regional banks have begun pulling back from the market, while larger money center banks remain cautious. Borrowers will need to recapitalize these equity infusions or sell assets as approximately $1 trillion of commercial real estate loans mature in 2023 and 2024.

Notably, the CRE lending market is highly competitive for stabilized in favor assets, with insurance capital, very active. This environment warrants patience and discipline, with a particular focus on liabilities with duration and durability, considerations we have had front of mind in building KREF. Despite the volatility, we have seen progress on a number of initiatives. First, we're in the late stages of a sales process on our risk-rated five Philadelphia loan. Second, our borrower is marketing a risk-rated four D.C. office asset, with initial indications above our $162 million loan amount. After significant progress on the business plan, the property is near stabilization, having signed over 70,000 sq ft of leases year to date, with total occupancy increasing from the low sixties to the high eighties. Third, many of our other office sponsors are signing leases.

Excluding the leases I just mentioned, our office assets have signed over 435,000 sq ft of leasing year-to-date, including the largest lease in Philadelphia in 18 months. Finally, subsequent to quarter end, our Oakland, California, office loan was paid down by 68% in connection with a lease modification and PACE financing, and we expect full repayment in the summer of 2024. KREF's steady focus on building non-mark-to-market financing sources and maintaining high levels of liquidity over the past few years has proved crucial in navigating this kind of environment. We continue to have ample liquidity, ending the quarter with $800 million of availability, including $208 million of cash and $560 million of corporate revolver capacity. We had no new loan originations this quarter as we focus on maintaining a robust liquidity position.

At quarter end, nearly 70% of our portfolio was comprised of multifamily, industrial, and risk-rated three office property types. The multifamily portion of our portfolio continues to perform well, with weighted average rent increases of 7.5% year-over-year. In the second quarter, loan repayments totaled $339 million, creating a net portfolio reduction of $162 million. With floating rate coupons at mid 8% today, versus takeout financing closer to 6% for stabilized properties, we are beginning to see borrowers opt for fixed rate refinancings. Beyond KREF, KKR is actively lending across a diverse CRE capital base, including bank and insurance SMAs and private debt funds, which allows us to stay active in the market and service our strong client relationships.

Our integration with KKR's broader real estate business, that manages $65 billion of assets, provides us with real-time market knowledge across both debt and equity. Our team of approximately 150 professionals has a strong reputation as a best-in-class capital solutions provider. We also continue to benefit from our long-standing banking relationships as part of the broader KKR franchise. As we have previously stated, we expect the portfolio to turn over modestly in 2023, and anticipate future funding should be offset by future repayments for the full year. A lack of capital market liquidity continues to challenge the office sector. We increased reserves this quarter, primarily driven by a higher reserve on an existing watch list loan that was downgraded to a risk rating of five in the quarter.

At this point, we believe we have identified all the potential office issues in our watch list and do not anticipate further ratings migration within the three rated office loans. While we are focused on long-term solutions to resolve watch list loans, we are seeking to maximize shareholder value. Where there is a dearth of liquidity, we have tools at our disposal to seek other options, including modifying loans and taking title and managing properties. I expect we'll have various outcomes as we work through the five rated loans. KREF was built for moments like this. We are operating KREF of $800 million of liquidity. 76% of our secured financing as of quarter end, was fully non-mark-to-market.

We upsized the master repurchase agreement from $240 million-$400 million, all while succeeding in terming out our debt, with KREF having no corporate debt or final facility maturities due until late 2025. We have a robust real estate business with a strong reputation across real estate equity, debt, and asset management. Finally, it is worth mentioning our manager's ownership of approximately 14% of KREF's shares outstanding today, which we believe is the highest percentage held by a manager in the mortgage REIT sector, and demonstrates meaningful alignment between KKR and KREF. With that, I'll turn the call over to Patrick.

Patrick Mattson (President and COO)

Thank you, Matt. Good morning, everyone. I'll begin by providing a CECL reserve and watchlist update, followed by our efforts on the capital and liquidity front. This quarter, we recorded a $56 million increase in our CECL reserve, for a total reserve of $228 million, or 304 basis points of our loan principal balance. This increase in our reserve was due mainly to additional reserves taken on our office loans risk rated five. Most notably, with the addition of the Mountain View, California, office loan that had a principal balance of $200 million at June 30th. Approximately two-thirds of our total CECL reserve is held against our three five-rated loans. The Mountain View office loan was initially placed on the watchlist in third quarter of 2022.

The property is a recently renovated, very high-quality, Class A office campus, but is located in a more challenged leasing market. We transitioned the asset to nonaccrual status in June. At this time, we are considering next steps for the asset, which may include taking ownership as we work with the sponsor on a transition plan. As we have noted in prior quarters, when loans move from a four to five risk rating, there's generally a meaningful increase in our loss expectation. Regarding our $194 million Minneapolis office, we have decided to modify the loan after testing the sales market. The loan was restructured this quarter with a two-year term and bifurcated into a $120 million fully funded senior mortgage loan, and a $79 million mezzanine note, including $5 million of proceeds for future leasing.

The senior loan is current on contractual interest payments through July. This property is well positioned to capture tenant demand, as it's one of the best buildings in the market in terms of both quality and location. It has leased over 100,000 sq ft over the last 18 months. The renovated Class A property is nearly 80% leased, with adequate cash flow to cover the senior debt service. As tenants seek space in well-capitalized buildings that can offer attractive leasing packages, we expect further positive momentum. The loan extension ensures the building is capitalized to fund leasing costs, as we feel this approach preserves optionality to optimize the value of the asset for KREF. On the risk-graded five Philadelphia office loan, we are working with the existing sponsor on a short sale process, in which we will provide financing to a new equity sponsor.

If the sale occurs, we'll recognize a loss through our cash metric of distributable earnings. We added one Boston office loan to the watch list this quarter, which is secured by a Class A office located in downtown Boston on Cambridge Street. The property is currently 90% leased, though given our conservative approach to identifying assets of concern, we downgraded this loan given the elevated loan-to-value ahead of the loan's initial maturity in first quarter 2024. Away from the watch list, our risk-graded three office portfolio, which equates to just under half of the outstanding principal balance of the office segment, continues to perform well and has attractive credit metrics.

In aggregate, the seven properties representing these underlying risk-graded three office properties are 93% leased, with a weighted average debt yield of 8.9% and a median eight point four-years of weighted average lease term remaining. Importantly, as Matt Salem mentioned earlier, we don't foresee any negative ratings migration on our remaining three rated office loans. The average risk rating of the portfolio was three point two, consistent with the prior quarter, and 83% of our portfolio is risk-graded three or better. Our portfolio is 99% floating rate, and in the second quarter, we completed our transition to SOFR, and now all our floating rate assets and liabilities are benchmarked to the market convention rate. One of KREF's key differentiators is the composition of its financing structure.

76% of our outstanding financing remains fully non-mark-to-market, and the remaining balance is mark-to-credit only. We continue to optimize, and in the second quarter, we upsized a $240 million master repurchase agreement to $400 million. Excluding match-term secured financing, there are no corporate debt or final facility maturities until fourth quarter 2025. KREF is well capitalized, with a debt-to-equity ratio of 2.2x and total look-through leverage ratio of 4.0x as of quarter-end. As of June 30th, KREF had $208 million of cash and $560 million of corporate revolver capacity available. The resiliency of our financing structure, coupled with our independence from the public capital markets, buffers KREF on the liability side during times of capital markets volatility. Thank you for joining us today.

Now, we're happy to take your questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Rick Shane with J.P. Morgan. Please go ahead.

Rick Shane (Managing Director and Senior Equity Research Analyst)

Hey, guys. Thanks for taking my question. The one disadvantage of being first is I'm still kind of pulling some data for the background on this question. If I trip some things up, I apologize. I'd like to talk a little bit about the Minneapolis transaction. Obviously, you cut the spread on the deal on the floating rate portion by about 150 basis points. The PIK component on the mezz, and this is, I think, the thing that surprises me, is fixed rate, and it's actually below the coupon on the senior. I guess a couple of things: Did the sponsor put in additional equity? To the extent this deal was restructured and extended, where is the upside for you?

What is the optionality that if this is presumably sort of by the sponsor, additional time in order to sell the property, where do you guys participate in the benefit of that transaction?

Patrick Mattson (President and COO)

Good morning, Rick. I'll take the question. It's Patrick. To answer specifically, no, there was no additional sponsor equity into this deal. As we've said, and as you know, this is a cash flowing asset. One of the benefits that we have here is that we've got an asset that is, you know, nearly 80% leased. It's got cash flow that can support debt service. The structuring really allowed us to play the asset forward here, continue to finance it at an attractive basis.

Gives clearly the sponsor some optionality here, but also gives us optionality to not sell into what's obviously not a great capital markets environment. So we're able to play it forward and look for a better time to sort of exit the asset. At the same time, we can continue to work with the sponsor, continue to maintain leasing at this asset, and like I said, look for a better, you know, capital markets exit.

Rick Shane (Managing Director and Senior Equity Research Analyst)

Got it. Hey, Patrick, two follow-ups to that. One is that you guys have made the comment that it's, it is covered on a cash flow basis, but that's on the senior side, at the 120. Would it have been covered at the prior coupon, at the prior note size, or does shrinking the note and shrinking the spread put you in that situation? The other side of this is, this is what I was trying to look up: Was the loan on nonaccrual before, so you will actually see a pickup in reported interest income because this loan goes from nonaccrual to accrual, even if it's smaller and at a, at a tighter spread?

Patrick Mattson (President and COO)

I'll take the second part first, Rick. You're right and observant there. We will see some pickup on this asset as we move it off of nonaccrual, the senior now, you know, will be a performing loan. You'll see that flow through, you know, our net interest. The asset, you know, prior to the restructuring, was very close to a one times DSCR. Clearly, with the recut here, the senior loan being smaller and at a lower coupon, that allows for excess cash to be captured within this asset. That cash then can be utilized very proactively to continuing the leasing efforts here.

Rick Shane (Managing Director and Senior Equity Research Analyst)

Got it. I apologize to my peers. I'm going to ask one last question. Will there be a catch-up in the third quarter related to the reversal of nonaccrual principal that was captured running through the interest line or anything like that? I just want to make sure there's no noise that we need to be thinking about.

Patrick Mattson (President and COO)

No, there's no recapture.

Rick Shane (Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Patrick Mattson (President and COO)

Thank you.

Operator (participant)

The next question comes from Sarah Barcomb with BTIG. Please go ahead.

Sarah Barcomb (Director of Real Estate Investment Banking)

Hi, everyone. Thanks for taking the question. We saw both the Boston office added to the watch list and the Mountain View office, you know, see that downgrade there. Both of those were originated post-COVID, and I'm hoping you can speak to the issues cropping up in that post-COVID office bucket, just given we've, you know, seen more issues, of course, in the pre-COVID bucket. Starting to see, you know, some of those issues crop up. Can you talk about how expectations have changed for that group since, call it, you know, early 2021 to now?

Matt Salem (CEO)

Hi, Sarah, it's Matt. Thank you for the question and for joining us this morning. I can try to take that. You know, I don't think that, you know, whether it's pre-COVID or post-COVID, you know, the properties or the loans are experiencing anything, you know, particularly different. I think it's just an overall market illiquidity and fundamental softness as well, as we just adjust to, you know, work from home and what the real demand is on office space. It's the same underlying theme that's impacting, you know, either when a loan was made pre or post-COVID. I would say our bar for lending on office certainly was raised materially.

You know, when we think about the world post-COVID, and maybe that's what you're highlighting here a little bit. You know, the Boston asset wasn't really a transitional asset. It was a fully leased asset. It's 90% leased today, so it was almost a stabilized office building and still is. It's just a question of value now, and with the market illiquidity and as cap rates have moved out. The Mountain View one's a little bit different. That's clearly a lease-up strategy from origination, but just given the overall quality of that particular asset, this is not going to be subject to some of the same concerns around occupancy and as we may have on some of the more generic office space in the market.

This asset will 100% get leased someday. It's a very high-quality asset. It's just going to come down to how long that takes and what's the, you know, what's the lease rate at that point in time. Hopefully that gives you just a little bit more context to that question.

Sarah Barcomb (Director of Real Estate Investment Banking)

Okay. Yeah, thank you. Thanks for that. Then maybe just to move over to the other side of the balance sheet for a moment here. I was hoping you could speak more to how you're thinking about liquidity and capital raising in the current environment, you know, depending on the messaging that we hear at the Fed meeting on Wednesday. Just given the amount of office exposure that's still on repo, you know, combined with the growing watch list, especially for assets where we've seen, you know, more of a valuation reset, and where KREF has lower net equity. You know, and you also mentioned in the prepared remarks that the money center banks are pretty cautious. I'm just trying to gauge how you're thinking about your liquidity needs going forward.

You know, at what point would you tap the corporate debt markets, you know, the term loan B markets? How are you thinking about that?

Matt Salem (CEO)

Yeah. I can take that. It's Matt again. I'd say, first of all, we have ample liquidity. Anything we would do would be more opportunistic in nature. We're not looking at the market saying we absolutely need to do something. You know, there's really no immediate need for liquidity right now. You can see we have $800 million of liquidity, there's ample liquidity there. I'd say number two, you know, we're going to continue to monitor all these markets. They've recovered along with the broader markets. To the extent, you know, we find something attractive, we could certainly look at that. You know, the one thing that's in the back of our mind is we did pay off our convert this past quarter.

It was small, but we paid it off. If there was an opportunity to term that out at some point in time down the road, you know, we may look at a potential opportunity to do that. Overall, I'd say we're just kind of watching the market and waiting for a moment where, you know, it could be attractive, but really no immediate need.

Sarah Barcomb (Director of Real Estate Investment Banking)

Thank you.

Operator (participant)

The next question comes from Jade Rahmani with KBW. Please go ahead.

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you very much. Good to see some positive updates on the office side. The first question would be, you know, how far along through the scoping of credit risks do you feel we are? Would you say halfway?

Matt Salem (CEO)

Fair

Jade Rahmani (Managing Director and Equity Research Analyst)

Fair assessment or, you know, much more along than that? I think you did take pains to mention that on the risk three rated office loans, you don't expect any negative surprises, and that portfolio is well leased with long duration. We haven't touched on multifamily hotels, industrial, and even life sciences, where we've seen a few hiccups. Can you just comment on that broad question?

Matt Salem (CEO)

Sure, Jade, it's Matt. I'll take that. Thank you for joining. Well, let's start with the, with the office, because obviously that's much, you know, much further along. I think with the office side of it, we feel like we are towards the end of certainly identifying where there could be potential issues. I don't think all four-rated loans end up migrating to five, and then it's a question of, you know, what happens with some of those as we continue to kind of walk down the, those, you know, the path there. As it relates to the five-rated loans, that feels like we've got pretty sizable reserves against those and appropriate reserves. The office, I think we've been pretty transparent. I think we've been a little bit more front-footed than some of our peers in identifying issues, reserving loans.

I think for us, we feel pretty far down the road, not finished, but pretty far down the road on the office side. As it relates to the other property types, I mean, it's hard to say. It's obviously could be early because we haven't seen any issues there. Clearly, real estate values have changed across the board with the increased cost of capital. The valuation changes have not been anywhere near as severe than what we've seen on the office side, which obviously is getting hit from fundamentals, as well as higher costs of capital, as well as capital markets and liquidity. It's a little bit of a perfect storm there. We're watching the portfolio very closely.

Even if you look beyond our broader portfolio, outside of KREF, we've got almost a $30 billion mortgage portfolio across all the different accounts that we service or manage. Really, we haven't seen any issues outside of office. I think a lot of those property types are well-positioned, and that's not to say that there won't be issues down the road because the debt burden is quite high today. That will impact certain sponsors. But I don't think even if you have issues, you're going to see the level. I would doubt you'll see the level of severity that we're seeing on the office side, which again, has kind of caught in that perfect storm.

It's a hard question to answer, but we're certainly monitoring it, and we just haven't seen anything in our broader portfolio or KREF's portfolio yet, on, you know, outside of office.

Jade Rahmani (Managing Director and Equity Research Analyst)

On the multifamily side, you mentioned the rent growth, 7.5%. I mean, we have seen multifamily performance being pretty resilient so far. Nevertheless, you know, for those loans to be able to successfully refinance, we're seeing some interesting dynamics where lenders are providing preferreds in order to have the LTV meet other senior lender requirements because the preferred gets counted as equity. Do you think that the multifamily deals can stomach a 6.5% or 6% type interest rate?

Matt Salem (CEO)

I think there's a timing issue there. The question is, what's the long-term tenured rate? I think there's a lot of sponsors today that are looking at their multifamily assets and trying to basically bridge the period of time from now to when you get into a little bit lower interest rate environment, at which point they're going to feel pretty good about the value of their asset. The question is: Does your sponsor have the liquidity to bridge that gap? There's going to certainly be business plans that are in the middle, and they're in the middle of renovating and upgrading units, that people will get caught in this a little bit, is my view.

I'd say for at least our portfolio within KREF, like, we feel pretty good about it. It's mostly Class A real estate. It's in liquid markets. The one thing I, it always surprises me about the multi-sector is the amount of liquidity there. There is a tremendous amount of liquidity on both the debt and the equity side. I think that's propped up values a little bit, and muted, you know, some of the issues that may be, you know, under the surface on the multi side. You know, I think to answer your question directly, I think that cost of capital is more temporary, so people are thinking about it on a more intermediate basis.

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you very much.

Operator (participant)

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

Don Fandetti (Managing Director and Senior Equity Research Analyst)

Yes, I was wondering if you're seeing any opportunistic capital forming in the industry for office, whether it's on the equity or debt side? I mean, obviously, sentiment's been extremely negative. Is that still the case, or are you sort of seeing some green shoots?

Matt Salem (CEO)

Go ahead, Don, I can answer that. I would say it's limited. I think part of the challenge with office is it's a large property type. Most investors, whether you're a debt investor or an equity investor, you have significant exposure to it. Everyone is kind of dealing with their existing assets and reserving whatever capital they have with those. It should be a pretty extraordinary investing opportunity, certainly given the illiquidity that we're seeing in the market today. I don't think we're seeing really large institutional capital being raised around, you know, around office.

Don Fandetti (Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Operator (participant)

The next question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws (Managing Director and Equity Research Analyst)

Hi, good morning. Patrick, would love to follow up. I think you made a comment on the short sale on the Philly office. You know, can you maybe help us get a gauge of how much the specific reserve, or of the reserve, it's roughly two-thirds on the five rated loans, kind of applies to that? Is that a 3Q event or sometime over the second half as far as timing goes?

Patrick Mattson (President and COO)

Good morning, Stephen Laws. We didn't give a specific number there, but if you look at what's implied by the numbers, you're talking about loss expectations that are, you know, potentially north of 25% on that asset and the other three rated assets. We're obviously still working through that sales process, and so want to be, you know, mindful of that. I think in terms of the timing, it's difficult to, it's difficult to predict right now. On one hand, it feels like things are progressing well, and as Matt Salem said, we're in the later stages here, so this certainly could be a 3Q event. But in this kind of market, for these types of transactions to slip a couple of weeks or a month, is certainly not impossible.

That's why we're saying could be a 3Q event, we would certainly expect it to happen by 4Q.

Stephen Laws (Managing Director and Equity Research Analyst)

Great. Thanks for the color there, Patrick. You know, repayments came in a little higher than I was looking for, a good bit higher than I was looking for, actually. You know, can you talk to that a little bit? It seems like you're, you know, reiterated today, kind of expect modest repayments over the year, which is consistent with last quarter. It looks like maybe a multifamily asset in Florida, a small resi condo loan, I think, in Manhattan. Can you talk about what repaid during the quarter and any trends we can read into that?

Patrick Mattson (President and COO)

Sure, Stephen. You're right, and we did have our condo asset, which is near Hudson Yards, had its last units sell, and that asset paid off. There were three other multis that actually paid off. They were paid off through a fixed rate refinancing. We're continuing to see, as some of these assets, in particular on the multifamily side, reach on their business plans, a real opportunity to take coupons that are in the 8%-9% when you look at the margin plus the SOFR index, and refinance at a rate that's, you know, closer to 6%. We saw some of that activity. We had a smaller number of partial repayments on some of our industrial loans, where there were asset sales.

I guess one thing I would just highlight, Stephen Laws, as we think about those, you know, repayments, those multifamily loans that paid off were certainly risk rated 3. If you recall, at one point, the condo asset was a risk rated four asset and obviously clearly was paid out at par here. You know, a pretty good quarter in terms of repayments. I think as we look forward, we still expect the back half of the year to be muted in terms of repayment expectations. If we see those, I would think that they're more toward the, you know, fourth quarter as opposed to third quarter.

Stephen Laws (Managing Director and Equity Research Analyst)

Great. Lastly, you know, Matt, what are you guys looking for to think about new originations here? I mean, it's, you know, seems like you feel pretty good about having identified problems in your office and feel good about what's currently remaining three rated. You know, are you looking for rates to top out? Is it more macro or, you know, what are the deals look like that you're looking at, you know, the past couple of months you've decided not to do, and kind of what do you need to see improve to start doing those?

Matt Salem (CEO)

Sure. It's a very interesting lending environment today. I'd say we're very much looking forward to being able to get back into the market and, you know, create some new opportunities in the portfolio. I would say, really, it comes down to just working through some of these watchlist items and just making sure that we get through them, we find a home, we get that equity returning to working. And then it'll come down to that. Outside of that, I think once we're through that moment, then, as we get repayments, we can go out and reinvest it.

That's really, I mean, part of the reason why we have been more aggressive with dealing with some of these issues, identifying them, trying to get through them, is because we very much want to make sure that we have the opportunity to take advantage of the current market environment. It's going to come down really to the existing portfolio, because I think what we're seeing in the market today is very attractive.

Stephen Laws (Managing Director and Equity Research Analyst)

Great. Matt, Patrick, thanks for the comments this morning.

Patrick Mattson (President and COO)

Thank you.

Operator (participant)

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

Arren Cyganovich (Vice President and Equity Research Analyst)

Yeah. I was wondering if you could talk a little bit about the West Hollywood loan that you modified in June, and, you know, what was the, you know, reasoning behind that and the outcome there?

Patrick Mattson (President and COO)

Sure, Arren, it's Patrick. I'll take that one. The real starting point here was just the interest rate movement and a cap renewal that had to be executed. When we did the modification, as part of the modification, the sponsor agreed to put additional capital into the asset. In addition to buying a cap, added additional capital to help cover debt service. We agreed, as part of the loan structure, to add some additional capital as well that will help carry this asset through its initial maturity date. As part of that modification, entered into some profit participation above our basis. You know, net-net, it puts the asset on sort of better footing for this current, you know, rate environment.

The asset, from an occupancy standpoint, continues to operate in the sort of mid-eighties here. That's something obviously we're watching closely. By the end of the day, this is a really high-quality asset in a great location, and we feel, you know, really good about our basis here.

Arren Cyganovich (Vice President and Equity Research Analyst)

Thanks.

Operator (participant)

The next question comes from Steve DeLaney with JMP Securities. Please go ahead.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Good morning, everyone. Thanks for taking the question. Yeah, I was prepared when we started the Q&A, or actually starting the call, to ask you about the three to five rated loans and if you saw any, you know, potential solution short of an actual foreclosure. Lo and behold, you showed us two of the three. You've worked something out, so congrats on that progress. Just curious, if we were to look at this, I know these are moving pieces, right? Both on the sale of Philly and the restructuring of Minneapolis. Maybe in a general from a general perspective, as you look at those two transactions and, you know, the accounting as you move forward, you have specific reserves, I assume, on all these five rated loans.

Do you think that your resolutions, as you model them out, will your specific reserve will be sufficient to kind of net you out flat once those two transactions are recorded? Thanks.

Matt Salem (CEO)

Hi, Steve, it's Matt. Thank you for joining us.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Sure.

Matt Salem (CEO)

Yeah, I mean, yes, I think that when we look at the sale and the modification, we think these reserves kind of match the current you know, current value expectations. That's, I think that's the question you're trying to get through is, I think we're appropriately reserved on those two.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Exactly. when those are. Obviously, whatever reserve you had and whatever, will there be, will there be any kind of a counting issue that we all struggle with this, you know, the GAAP and then the distributable. Do you think these transactions, will there be a distributable impact that the analysts, that we should be thinking about with respect to modeling? Jack, we can follow up, you know, offline. I'm just trying to understand and get it out there that, you know, this could be... Is this going to be an issue with respect to distributable beyond the fact that you're well reserved, you know, on CECL?

Matt Salem (CEO)

Yes. I mean, if we have a loss, the CECL is going to translate through to DE.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Yes.

Matt Salem (CEO)

I think we mentioned that on the prepared remarks as well. The most obvious one is, if we get to a sale on Philly, our CECL reserve, where we think we're appropriate reserved, will flush through, if you will, you know, DE at sale.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Yep.

Matt Salem (CEO)

you know, we'll see what we get to. Yes, at some point in time, you'd expect some of these CECL reserves to be realized.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Great. Now, in the case like that, you actually take a property back. Let's say, you know, you foreclose on Mountain View. At that point, I assume, and you're going to hold it and you're going to operate it, optimize it for a year, a couple of years. That REO would come on at fair value. If you actually do foreclose, convert it from a loan to REO, is that also a situation where the REO would be booked at current fair value that could trigger a, you know, a realized loss?

Matt Salem (CEO)

Yes. Yeah, if we went to title, like you said, we would value the asset-

Steve DeLaney (Managing Director and Senior Equity Analyst)

Yeah.

Matt Salem (CEO)

We would take a realized loss on the difference between, you know, our basis and that value.

Steve DeLaney (Managing Director and Senior Equity Analyst)

Okay, great. That's all that's helpful. I guess this is not a question, but maybe a request. As these situations play out, with respect to actual closings of these anticipated, it'd be great if you guys could consider, you know, an 8-K or maybe a press release, just alerting the analysts and the investment community that, you know, that transaction is now closed. Therefore, like in three Q, you have imagine, you know, could it happen in three Q or is it could slide to four Q? You know, we'd love to have the opportunity to tweak, you know, so that, you know, that we're not out of line, if you, if you will, with respect to where you see your distributable coming, your DE. Thanks. Thanks very much.

I'll just leave it there. Thank you very much for your comments.

Matt Salem (CEO)

Thank you.

Operator (participant)

As a reminder, if you have a question, please press star then one to enter the question queue. The next question comes from Jade Rahmani with KBW. Please go ahead.

Jade Rahmani (Managing Director and Equity Research Analyst)

Thank you very much. Just curious, if you have a borrower, where you have multiple deals and one of the deals, you know, you're in discussions on because it's having issues, you know, do you make relationship-based decisions or everything is case by case with respect to an individual deal?

Matt Salem (CEO)

I mean, it's really a case-by-case basis, Jade. I mean, we're trying. If we've got an issue and we're dealing with a sponsor, we very much are trying to optimize the outcome on the issue loan. I think we're taking those individually and seeing the, you know, what kind of outcome we can get to.

Jade Rahmani (Managing Director and Equity Research Analyst)

On Minneapolis, let's say the sponsor there has several other deals that, you know, they're not in the same position, but they could have some issues down the road that you're aware of and anticipating. It's just not at the same risk level. You're not gonna talk holistically?

Matt Salem (CEO)

It really depends. I mean, although you say same sponsor, in many cases, it may be the same sponsor, you have different funds or different, you know, equity capital involved. We may have it in different portfolios as well. To the extent it's just KREF on a bilateral negotiation with the sponsor that has the same kind of equity base, then, they want to talk about a holistic solution, like, of course, we could have that conversation. That's not typically how it goes. You're usually just in front of them on one deal and negotiating that.

Jade Rahmani (Managing Director and Equity Research Analyst)

Okay. The second question, just to really put a fine point on what Steve DeLaney was asking and also, what Steve was asking earlier. The Philadelphia sale, the short sale, is that going to hit book value further than what's already reserved?

Matt Salem (CEO)

It's not our anticipation. You know, nothing's done in this market until it's done. We think we're appropriately reserved at the kind of current expectation of the sale price.

Jade Rahmani (Managing Director and Equity Research Analyst)

Okay. Thanks so much for taking the follow-ups.

Matt Salem (CEO)

Thanks, Jade.

Operator (participant)

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 (Director and Head of Investor Relations)

Well, great. Thanks, operator, and thanks everyone for joining today. You can reach out to me or the team here with any questions. Take care.

Operator (participant)

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