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KKR raises US$950m for fund dedicated to riskiest CMBS

[NEW YORK] KKR & Co has raised US$950 million for a fund dedicated to buying the riskiest slices of new commercial mortgage-backed securities (CMBS) as it expands in a part of the market that has been battered by the Covid-19 pandemic.

The firm closed KKR Real Estate Credit Opportunity Partners II, a successor fund to a US$1.1 billion vehicle it raised in 2017 to buy so-called "B-pieces" of CMBS. Such slices are the first to take losses when mortgages underpinning the securities sour.

KKR is among the most active buyers of B-pieces, which banks and other financial institutions often seek to offload at steep discounts. Risk-retention regulations mandated by the 2010 Dodd-Frank Act require market participants to keep slices of CMBS as a form of "skin in the game", though they're allowed to sell the portions to third parties like KKR that hold the securities on their behalf.

In the first half of 2020, B-piece buyers purchased about 60 per cent of deals' required risk-retention portions. KKR has invested more than US$1.25 billion in the securities since 2017.

Junior portions of CMBS have dropped this year as investors fret about the future of commercial real estate amid a pandemic-induced economic slowdown. The fund recently paid US$37 million for a US$92 million face value position in the junior tranche of Wells Fargo Commercial Mortgage Trust 2020 C-56, which translates to a price of about 40 US cents on the dollar.

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"That same investment in a pre-Covid environment would have priced around 50 US cents," Matt Salem, head of real estate credit at KKR, said in an interview.

Mr Salem said he's optimistic about B-piece performance because loans backing the properties hardest-hit by the pandemic, like hotels and malls, have largely been removed from new CMBS. That leaves lenders with exposure to multifamily, office and industrial real estate, he said.

The KKR fund targets annualised returns of about 12 per cent before fees and has spent US$259 million through June 30 across nine transactions, Mr Salem said. Its two-year investment period runs through mid-2022.

As the purchaser of the most junior part of the CMBS, KKR determines the overall risk of the pool of loans backing the bond and has a say regarding which mortgages are included, Mr Salem said.

Investors in the latest fund include the Virginia Retirement System and Indiana Public Retirement System, according to data compiled by Bloomberg.

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