Broadmark Realty Capital Inc (BRMK) 2022 Q3 法說會逐字稿

Greetings, and welcome to the Broadmark Realty Capital Third Quarter 2022 Earnings Call. (Operator Instructions) As a reminder, this conference call is being recorded.

It is now my pleasure to introduce your host, Nevin Boparai, General Counsel. Thank you, sir. Please go ahead.

Good afternoon. Thank you for joining us today for Broadmark Realty Capital's Third Quarter 2022 Earnings Conference Call. In addition to the press releases issued this afternoon, we've filed the supplemental package with additional detail on our results, which is available in the Investors section on our website at www.broadmark.com.

As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filing.

During this call, we will also be discussing certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are contained in our earnings release and SEC filings.

This afternoon's conference call is hosted by Broadmark's Interim Chief Executive Officer, Jeffrey Pyatt; Interim President, Kevin Luebbers; and Chief Financial Officer, David Schneider. Management will make some prepared comments, after which we will open up the call to your questions.

Now, I'll turn the call over to Jeff.

It's been a busy time here at Broadmark. This afternoon, we announced a change in leadership for the company. I have assumed the role of Interim CEO, and Kevin Luebbers, a director and Chair of the Audit Committee, has been named Interim President. The Board is in the process of launching a search for a new Chief Executive Officer, and Kevin and I will serve in our roles until that individual is hired. Also, Kevin and I will remain members of the Board, and I will continue to serve as its Chairman. These appointments follow a mutual agreement to separate between the Board and Brian Ward, who will leave his role as CEO and resign as a director of the company, effective immediately. We thank Brian for his contributions to Broadmark and we wish him all success in the future.

Additionally, I am pleased to share that Jonathan Hermes has been hired as our Chief Financial Officer, effective December 1, 2022. He is a highly capable financial leader, with technical accounting and capital markets experience. Jon is no stranger to Broadmark, as he worked closely with the company when we were going public. Jon will succeed David Schneider, who previously announced his intention to resign to accept an opportunity as a private -- at a private company. David will remain with Broadmark until year-end to ensure a seamless transition. Given this is his last call with us, David, on behalf of the Board of Directors, we thank you for your numerous contributions and help with the transition and we wish you all success in your next chapter.

While we have experienced significant leadership change over the past year, the foundational principles of our business remain unchanged. We founded Broadmark over a decade ago in the wake of the global financial crisis. So we know a thing or 2 about navigating choppy waters. We built this business from the ground up and have been tested through multiple economic cycles. We have a long history of successfully deploying capital and we have originated over $4 billion in loans since inception. Through it all, we have lived up to our commitments to our borrowers and thrived as a trusted go-to provider of capital.

The keys to our success have been woven into our DNA from the beginning. We are disciplined underwriters, requiring significant equity from our borrowers. Our loans are generally short term in nature, allowing us to reprice our book with relative speed. Notably, we have always operated with little or no debt, significantly reducing risks associated with liquidity, refinancing, and interest rate exposure. As we look to the future, we remain confident in our cycle-tested strategy. We are diversified across the national footprint and have a deep and experienced team of ground-level real estate investment experts. As we manage our existing portfolio and the current economic and financial market turmoils subsides over time, we believe we will emerge in a strong position to take advantage of the opportunities that arise to resume growth and create value over the long term.

I'll now turn the call over to Kevin to share some additional perspective.

Thank you, Jeff. Good afternoon, everyone. I'd like to comment a bit more on the external environment and on one additional announcement we made today.

2022 continues to bring unprecedented challenges to the global economy, real estate, and the financial markets. Persistently high inflation has forced the Federal Reserve to rapidly increase rates, greatly impacting asset values in the near term. 30-year residential mortgage rates have risen from roughly 3% 1 year ago to over 7% today, and commercial mortgage rates have followed a similar pattern. And while overall employment has continued to grow, real wages have declined and there are increasing signs of recession risks amid a backdrop of political uncertainty.

With countervailing risks of inflation, along with the rising rates and recession fears, financial market volatility has hit levels not seen since the global financial crisis in 2008/2009. Virtually all equity and fixed income assets have been significantly impacted. Despite this environment, we believe that Broadmark is positioned ultimately to thrive as opportunities arise, as they always do from market dislocation and uncertainty, we believe over time, we will be able to capture more than our share as we move ahead.

Beyond originating new business and ongoing critical priority that we're focused on is effectively addressing our non-performing loans. Capital is precious, and while we have confidence we will ultimately resolve those loans in a manner favorable to Broadmark, until they are resolved, it continues to create a drag on our growth and our earnings. To that point, the team will remain hyper-focused on this issue. David will provide additional detail, but we wanted to call out that this will continue to be one of our most important areas of focus.

Let me now turn to our share repurchase program. Today, the Board approved a share repurchase program to purchase up to $75 million of common stock. We remain committed to continuing to source and fund new loan originations, but we recognize the value of our company and wanted an additional capital allocation lever on which to potentially act opportunistically in the future.

I'll end by saying that the Board has taken decisive actions on behalf of shareholders and stakeholders to ensure the company is positioned with strong leadership and clear strategy to weather the current environment and create long-term value. With an experienced team in place and the lowest levered balance sheet in the industry, Broadmark is poised to build the business in a disciplined and thoughtful manner. I'd like to thank our team for their hard work and contributions and while this will take some time, we believe we are taking the right actions to move forward and achieve long-term success.

And with that, I'll turn the call over to David.

Thanks, Kevin, and good afternoon everyone. Our operating results are detailed on Slide 7 of our earnings presentation. For the third quarter of 2022, we produced total revenue of $27.1 million and net income of $2.6 million. On a per share basis, this reflects GAAP net income of approximately $0.02 per diluted common share. The quarter-over-quarter change in GAAP net income reflects an increase to our CECL loan loss reserve of approximately $0.07 per diluted common share. This increase was primarily due to an increase in specific loan loss reserves of $9.6 million that I will discuss shortly. Adjusting for the impact of non-recurring costs and other non-cash items, our distributable earnings prior to realized loss on investments for the third quarter were $18 million or $0.14 per diluted common share. Interest income on our loans in the third quarter was $20.7 million, and fee income was $6.4 million.

On the expense side, for the third quarter, we had cash compensation and employee benefits expense of $2.7 million, while G&A was $3 million. Our total cash compensation and G&A expense improved 3.4% from the second quarter of 2022, and with $18.3 million in expense year-to-date, we maintain our expectation of approximately $24 million in total cash compensation and G&A expenses for the full year 2022.

In the third quarter, we executed on 18 loan originations, with an average loan size of $7.8 million at an unlevered yield of 12.9%. As a reminder, our loans remain short term with a weighted average term of 14 months at origination for the third quarter. The short-term nature of our loans reduces our exposure to interest rate fluctuations. It also allows us to be nimble and pivot fairly quickly as the environment evolves.

Turning to portfolio management, as of September 30, we had contractual default rate of 19% of the total portfolio by value. During the third quarter, we foreclosed on 1 small loan and received payoffs on fixed loans in contractual default status, representing $18 million in total commitment. At the end of the quarter, we owned 11 foreclosed properties with $93.5 million in carrying value.

As I noted earlier, our CECL reserve was up in the third quarter. This was primarily due to a specific $9.1 million loan loss reserve associated with a loan collateralized by a hotel in Colorado, with the borrower in bankruptcy and have failed plan to flag the hotel, resulting in material deterioration in the appraised value. As a reminder, our portfolio is less than 5% hotels and weighted towards single and multifamily collateral with substantially lower LTVs, and we do not believe this troubled loan is representative of our broader portfolio. Outside of the specific reserve, we noted a 13% increase in our aggregate CECL general reserve based on consideration of current macroeconomic factors.

From an earnings perspective, as of September 30, we had approximately $115.4 million in principal outstanding on loans in non-accrual status and foreclosed properties, which resulted in a drag on earnings of approximately $0.05 per diluted common share for the third quarter of 2022. As Kevin mentioned, effectively addressing our non-performing loans remains a high priority, as we continue to work diligently to resolve these issues to achieve the best results for Broadmark and in a manner accretive to shareholders. Ultimately, we strive to generate strong cash flow and earnings growth. So, effectively executing on this strategy is essential, as we work to maximize performance.

Now, turning to our balance sheet, as detailed on Slide 16 of our earnings presentation, with $61 million of cash and a fully undrawn $135 million credit facility, our total liquidity at $196 million as of September 30. While our loan payoffs were significant in the third quarter of 2022 at $198 million, this was largely due to a few expected prepayments on storage facility loans. However, given the changing economic backdrop, we began to see a slowdown in payoff activity in October associated with a decrease in available takeout financing in the market. We continue to work with borrowers to find exit opportunities, as we focus on capital and liquidity preservation.

With our $100 million of 5 year, 5% fixed coupon senior unsecured notes outstanding, we currently have a debt-to-equity ratio of 8.8%, which remains the strongest in the mortgage REIT sector. Maintaining a fortress balance sheet has always been a foundational principle for Broadmark, and this provides a significant competitive advantage in the current environment that will allow us to remain opportunistic with an evolving market environment.

With that, I'd like to pass the call back to Jeff.

Thank you, David. We understand that we delivered a significant amount of news this afternoon. Given the circumstances, the Board will continue to take clear, decisive action on behalf of shareholders as necessary. We have a leadership team in place that has significant and proven industry experience that will work together to unlock long-term value. We understand this will take time. But we know the right path forward and given our alignment of interest with our shareholders, we can and will achieve the desired results.

This concludes our prepared remarks. We will now open up the line for questions. Operator?

(Operator Instructions) The first question we have is from Stephen Laws from Raymond James.

I guess, the first I want to start with talking to you, the management change. Can you talk about timing of what you think it'll look like to get the new permanent team in place, any search expenses, severance expenses we need to think about in the model and -- that I believe David gave a comment on the full year, but how do we think about expenses around the turnover?

I'll let David address those parts. But this just happened, Stephen. And so, the Board is going to begin a search to find a new CEO, and I think the important takeaway there is that Kevin and I, who both have a lot of experience working together in this company, are committed to being here until we find that person and get him or her up to speed.

And then David, you want to discuss the costs and so on, that part of the question?

Sure. Yes, absolutely. Thanks. Thanks, Stephen. Great to hear from you. So the current structure with the leadership changes that we described with -- specifically with Jeff and Kevin coming on board, those will have no material expense. In fact, there is probably a bit of a net savings from that perspective. Longer term, to your question, if we do engage a search firm, there could be a potential search fees associated that's similar to what we incurred in the first quarter of this year. But it's probably too soon to tell what that number would be. So, I think right now, I'm still comfortable running with the $24 million of cash comp and G&A expenses, and we can provide you an update in the interim or in the fourth quarter.

All right. To think about the investment portfolio, I saw on a footnote on the supplement, I think you did your first mezz loan at $10 million. Given the change and the increased focus on asset management or continued focus on improved portfolio performance, how do you think about portfolio transition or appetite for mezz loans? Is that something you'd be -- sort of put on hold until you get the new team in place, or how do you look at that?

Jeff, why don't you take that on the mezz loan piece?

Apologies. It seems Jeffrey has dropped off, and he is in the process of reconnecting with us.

So, Stephen, I'll take this. This is Kevin. No change to the strategy. Broadmark has always made loan decisions based on underwriting and attractiveness, and so they'll continue to do that. But it's early days. So, we're going to look at all that.

Dave, do you have anything to add?

No. I mean I think when we did the first mezzanine loan, we said don't expect this to be a large portion of our portfolio. I think the focus is just on finding good risk-weighted investments, while also kind of juggling that with capital and liquidity preservation. So, doesn't mean we're going to do a bunch of mezzanine loans. It doesn't mean we won't do mezzanine loans. I think we're just looking for good opportunities to deploy capital, while being mindful of the current macro environment.

Great. And when we think about the dividend level versus current portfolio earnings, given the performance levels, how do you think about the trade-off of continuing to maintain a stable dividend that's not being covered, or do you think about right-sizing the dividend and increasing it back up as portfolio performance improves?

I'll take that one. Ultimately, Stephen, this is a Board decision that is reviewed and determined each month. So, in light of the rapidly changing business environment, management is taking a hard look at the business. That work is ongoing and will take a little time. The Board's policy is always strive to set a dividend that is sustainable and that over time is covered by distributable EPS. But again, it's a Board decision, and they'll continue to review and determine it each month.

(Operator Instructions) The next question we have is from Steve Delaney from JMP Securities.

Probably wasn't part of -- necessarily part of your plan 6 months ago. But I respect you have a lot of talent to bring to bear and the company is lucky to have you to step in.

So we are in a very different world than we were 6 months, 12 months ago from a real estate standpoint. Brian, there was obviously some enthusiasm he referred to a rebranding, I think just maybe trying to raise visibility and broaden products. Unfortunately, maybe where we are right now in terms of priorities in the market for all real estate lenders, maybe broadening or expanding is less important than focusing on the existing portfolio.

I guess, my question there is about your current lending focus. Can you talk about what you're comfortable doing and -- you're having repayments, obviously, come in, although the next part of my question is the slowdown there. I was caught by David's comment about takeout financing and that seems logical. So, as we think about it today and as your team comes to work, what is the, like, intensity or focus about generating new credits, relative to where it may have been over the last couple of years? Can you just comment that -- on that and whether there is a different level of selectivity, yield requirement, et cetera at this time in your lending appetite?

Sure. That's a lot packed into that question, Steve.

Yes.

And I guess, the overarching theme is that whether I was in the seat or Brian, or now me again, we have never changed from our strict underwriting standards. We -- when you and I first met, I think we were in 9 states. We're now a national lender. We look at every market with the same careful eye that we always have and so -- and every loan opportunity. And so, we still make sure that we're paying attention to loan-to-value ratios, to loan-to-cost ratios, to all those things that have always been underpinnings of our loan portfolio. And in these markets, it's -- it is an uncertain time. And so, we probably want to look a little more carefully. Not -- that's probably not the right term, but we want to continue to look carefully and just make sure that we're underwriting good loans.

This is Kevin. Let me just add a little bit to that. And I think careful is an appropriate word. Payoffs are an important source of capital for us and -- for the reasons David mentioned, rising interest rates, rising cap rates, the exits are difficult for our borrowers and we expect that they will be for who knows how long. But -- so, we're just being cautious and careful, but we are a lender and so, we're going to continue to make good loans where they are available.

And on your borrower situation, I assume if you have a good property and you have a recently responsible borrower and he is basically just saying, one, normally you would think okay if I complete it, I sell it; two, I just -- I re-fi it in some fashion. You have a certain term. You're in there for the renovation or construction, and you're not in there necessarily for a 5-year loan. This is your primary. If it's a good borrower and a good property, is the logical thing to do just to provide extensions and have that developer get more involved in leasing or whatever the strategic plan was for the property, if in fact a new operator can't be brought into the property or, in fact, for -- on your REO? You guys have a lot of expertise. Do you -- are you thinking about something for your REO if there's just not going to be a bid that you like to kind of take over and manage that property in the interim and try to write this thing out without giving away property?

Kevin or David, do you want...

Yes. Yes, I'll take it. I'd say it's -- Steve, it's a case-by-case basis, and that's exactly what we're working on. The answers are different depending on the situation.

Well, listen, I know it's a challenging time. You've got a great fortress balance sheet, and I'm sure that you'll come through it, and applaud the effort on the buyback. And I can echo Stephen Laws' comment. The dividend's, obviously, a Board decision. There's going to be a lot of dividends reconsidered simply -- one, a 15% yield is kind of crazy. But two, you got to balance it against liquidity needs and the buyback opportunity. So, nobody signed on buying your stock thinking that we're going to get 15% yield. So, I'll just leave it with that thought and wish you all well and good health.

The next question we have is from Crispin Love from Piper Sandler.

Just starting with the leadership transition, Jeff, I'm just curious, why now for the change in CEO as Brian's just been in the seat for about 8 months or so in what's been a very difficult economic environment. And just related to that, do you expect any strategic changes with a new CEO?

The why now, I think the answer is that the Board and Brian sat down and looked around and decided this was the right time. And I think -- I don't think I can go much beyond that candidly. And then as far as strategic changes, Brian did a lot of good work around here. I don't see us unraveling all of the good work that he did, if that's the question. And we've got great management in place, the underwriting and the portfolio management are all good folks. And so, I really think the underpinnings are good for where we are.

That's helpful. And then a second one, just on loans in contractual default, so they're now just under $290 million. Can you just speak to some of the key reasons for the continued increases that we've seen? Is it due to being more aggressive in putting loans in contractual default, which Brian has talked about in the past, or is it the current environment or, just curious, what else might be at play here?

This is David. I'll take this one and let Kevin and Jeff comment as needed. So, I think we were up quarter-over-quarter about $60 million in defaults, and the biggest driver I would say is primarily the latter in terms of being more aggressive. I can note that I think $40 million out of the $60 million was us deciding to strategically put 7 loans, 6 of them were performing, 1 was default, with the same borrower, and we decided to put the whole package in default just to expedite the process around. Probably the most valuable, but risky loan that -- the one in default. So, we're making a little bit quicker decisions around putting borrowers in default, exercising our right to start the foreclosure process to put a little bit more pressure and just trying to find more timely exits.

In the third quarter, I think we had about $18 million of defaults resolved. In October, I want to say we were about $20 million, and we're expecting kind of a little bit of an increased pace consistent with that on a monthly basis just by way of being a little bit pushier, being a little bit tougher, being more aggressive with foreclosure actions or threaten foreclosure action and finding ways to exit as quickly as we can.

And just one last one from me, just on the $12 million provision in the quarter. Was that provision -- was it all due to the Colorado hotel loan? And then what is the size of that loan?

Sure. I'll take that one, Crispin. It's nearly totally driven. So I think our increase quarter-over-quarter was about $10 million, and $9.1 million of that was a specific reserve on this one Colorado World Resorts loan. It was about a -- about a 40% discount to the principal outstanding in the appraised value that we had originally expected on it.

The final question we have is from Matthew Howlett from B. Riley.

My question is on the buyback. I mean, Jeff, I think a lot of shareholders are going to ask the question. I'm curious to hear the answer. When you look at buying back shares today, your stock's roughly at a 30% discount to tangible book value. You look at that for us originating loans at 13% unlevered, what can you tell us in terms of the propensity of the Board today to aggressively pursue share repurchases in light of the stock's discount to tangible book, and what metrics do you look at versus -- originating versus buying back shares?

Kevin, would you handle this one, please?

Sure, sure. The Board did approve a $75 million share repurchase program. It's just one additional capital allocation lever that we think is prudent to have. So in terms of our use of capital, our main business is to source and fund loan originations. But we do understand the value of our company. And again, we thought it was prudent to have this additional lever, on which to potentially act in the future. I'll also say that we announced the plan, but the amount, the timing, the execution, all of that is part of our overall capital allocation strategy, which will determine over time. So not much to add in terms of price or expectation, or all that kind of stuff.

In terms of the dividend, you asked about that, obviously, it's a balance. It's -- both are taken in consideration. Our shareholders expect dividends. Our goal, as I said, is to set a dividend that's sustainable over time and covered by distributable EPS. So, we'll continue to do that, our Board will continue to do that. This is just another use of capital lever that we now have.

Got you. But when you look at -- obviously, is tangible book value of the stock price to tangible book, a good reason -- reasonable proxy on when it would be attractive to buy back shares versus originating. I mean, just walk me through the accretion sort of analysis. I guess, my question is, why wouldn't that take priority when the stock is at tangible -- meaningful discount to book?

It's something we'll analyze, but I can't tell you exactly what the price is or how we're going to look at it. We put the plan in place and now, we intend to do the work and execute when we think it's appropriate.

Okay, fair enough. And then on that -- on the topic of yield, I mean, obviously, there was guidance of yields falling over time, I think 10% to 12% earlier (inaudible) 13%, I mean, with spreads now, higher interest rates, I mean, is -- can we sort of look at our models and say, the margin, the spread -- the unlevered spreads are going to start moving the other way, given the environment we're in, or is something else there?

I'll say something just generally, and then I'll turn it over to David for more specifics. We do think, given all the dislocation, that there will be opportunities. We want to be poised to take advantage of those opportunities. It might be -- it's still very early. There is a -- so -- but in terms of kind of where we see that, I'll let David answer the questions more specifically.

Sure. Thanks for the question, Matt. This is David. Yes, so we were at 12.9% on new originations on yield unlevered this quarter. I think last quarter, we were around 10.1%. So I think we talked a little bit last quarter about there being a lag in timing in terms of price discovery from bid-ask spread on construction lending. So I think this was the first quarter we started to see that close. Now I would say some borrowers are probably hesitant to pull the trigger and do new loans, given the current macroeconomic environment. But we did finally start to see that gap close a bit from the bid-ask spread and it went in our favor. So I think we said in our prepared remarks, expect to be somewhere around 12% to 13% at least in the near term, and that's -- I think that just feels good based off this past quarter.

Got you. And I guess, just the last question while I have you, I mean, clearly, the priority is to get through the non-accruals that cost you free cash and capital, but what -- are the debt markets -- I mean, are they available to Broadmark? And we talked about in the past, I mean, maybe not -- maybe things have changed now. But I mean, what -- you look at the leverage, it does stand out. I mean, there's nothing, obviously, due for well, 8.8%, but I mean, what -- what's -- when you talk about issuing debt, what can you tell us in terms of where you can issue at?

Sure. I mean, I'll take this and let Kevin and Jeff chime in as well. I mean, right now, it doesn't seem like the time to be raising capital. We still continue to have conversations where we're ready to access the capital markets if they -- if we see some windows of sustainability. But current market, you can see how few transactions there are. So, as I -- we certainly wouldn't be able to execute at a 5% fixed rate coupon like we did in November. I wish I could go back in time and triple the size of that. But I think in terms of cash liquidity position, we feel good about where we are for now. We're measuring that against our origination pipeline, other demands like the dividend and where share repurchases could come into play in the future.

So, I think there's a few different levers that we're measuring. But we don't need capital right now. Now, it feels like a time where if you're raising capital, it's a bit of a really urgent need or desperation, which we're not in that position. So, we continue to monitor it and hopeful that we'll see some more transaction volume in the near term.

I would just add -- I would echo what David said, but that -- the job is to stay in touch with the capital markets, like all REITs need to stay in touch. It's a capital-intensive business. We need capital. So, whether now is the right time, I don't disagree with what David said, but that can change. And so, we need to just be ready. And so, that's what we'll try to be.

My question asked another way, but do you still feel like the model could support when the time is right, a turn of leverage or half -- something where there is leverage on the balance sheet?

No decision. So, I think it all depends on how everything -- it's just another decision that we make. It depends on loans that we can originate. So, no, I'm not signaling anything more than that. It's just being in touch with the markets. I think, as David has mentioned in past calls, we constantly evaluate the capital markets and make decisions all the time. So, we'll just keep doing that.

Good luck on the search and we'll await an update.

That concludes the question-and-answer session. I would like to turn the floor back over to management for closing remarks. Jeffrey, please go ahead, sir.

Thank you, everyone, for joining us. One last time, David Schneider, we all wish you the very best, and I look forward to speaking with all of you on our next call. Thank you.

Thank you, sir. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.