Broadmark Realty Capital Inc (BRMK) 2020 Q4 法說會逐字稿

Good afternoon, and welcome to Broadmark Realty Capital Fourth Quarter and Full Year 2020 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to Navin Boparai from Broadmark General Counsel. Please go ahead.

Good afternoon. Thank you for joining us today for Broadmark Realty Capital's Fourth Quarter and Full Year 2020 Earnings Conference Call. In addition to the press release issued this afternoon, we have filed a 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 filings.

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 Chief Executive Officer, Jeff Pyatt; 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 will turn the call over to Jeff.

Thank you, Navin, and welcome to our fourth quarter and full year 2020 earnings call. We hope that all of you and your families have remained safe and healthy. This afternoon, I'll begin by discussing our 2020 performance and share some thoughts on our exciting opportunities for growth as we look ahead. Then I'll turn the call over to David to provide additional detail on our financial results and the loan portfolio and some key updates on enhancements to our balance sheet and funding sources. We will then open up the call for your questions.

We just concluded our first full year as a public company. While it was not the year any of us expected, we feel it provided a significant validation of our lending platform, primarily focused on residential construction, which has served us so well for the last 10-plus years. Through a combination of disciplined underwriting, balance sheet strength and the excellent work of our team members, we overcame the challenges presented by COVID, and we believe we emerged stronger than ever.

In the fourth quarter, we generated over $190 million of originations and risk-reducing amendments, surpassing the level of many of our pre-COVID quarters. In addition, we accomplished this in a quarter when originations are typically slower due to the holiday season. This was primarily due to an acceleration in the second half of 2020 as construction halts were lifted and market activity began to normalize. It also speaks to our financial flexibility and our ability to be nimble and seek out opportunities even in a challenging environment.

We finished the year with a total loan production of more than $625 million, an exceptional result in a difficult year. We believe our performance demonstrates not only our resilience, but also the power and potential of Broadmark's lending platform. Much has changed over the past year, but the urgent need for new housing construction is more acute than ever with historically tight housing inventory and record low mortgage rates.

While the pandemic caused a temporary bottleneck in construction, we have always been focused on markets in which population trends are creating long-term secular demand for the types of projects we fund. We have historically focused on 14 states plus Washington, D.C. as markets with some of the best growth trends in the country, supported by lower costs and job growth. Our portfolio is 56% residential loans, and we lend in 7 out of the top 10 states with the largest housing deficits.

Our credit and investment committees continue to review additional states that are best suited to extend our lending activities, and we look forward to sharing additional updates on those efforts in the near future. We know, however, that we are in a highly competitive market, which has seen significant capital inflows over the past year. Interest rates remain effectively at 0 and new entrants as well as existing lenders are aggressively pursuing attractive yields in the world of construction lending.

While we view this intense investor interest as a validation of our business model, we note that the heightened competition could drive increased variability in our originations from quarter-to-quarter. It will require us to remain disciplined as we historically have been, and we will continue to evaluate our pricing relative to appropriate risk levels across our markets and project types. We are confident that in the long run, our expertise and reputation as a lender of choice will continue to give us an edge over our competitors. We also operate in a large and highly fragmented construction market, and we believe we can continue to drive earnings growth even with conservative market gains.

Next, as David will discuss shortly, we have made some key enhancements to our capital structure that we believe will help us unlock significant growth. Earlier today, we announced the completion of our revolving credit facility. Given the nature of our business, we have historically needed to maintain large cash reserves to fund the construction draw process. This new credit facility will allow us to more efficiently manage our cash from quarter-to-quarter, as we work through the funding process of our short-duration loans, in turn, freeing up significant existing capital, which we will use to grow our loan portfolio.

With regard to our current portfolio, we have previously discussed how the multiple effects of COVID from permitting and inspection office closures to construction halts, delayed the completion of some of our projects. And in some cases, we continued to work through these issues. We've stated that it will take some time to work through these project delays, but we believe that our resolution process will produce the best outcomes for Broadmark, as we have always benefited from our reputation as a reliable partner on our builders' projects. Importantly, we believe the value of these projects has not significantly changed, and we remain protected by our prudent underwriting and active portfolio management in the unlikely event that we need to take a project over and sell it.

As an update, we reduced our population of loans in default by 10% in the fourth quarter relative to the third quarter and continue to find default resolutions that generally result in full collection of principal and interest outstanding. The default management effort will continue in 2021 as we work with our borrowers to find the best economic outcome for the company and its shareholders, but we remain confident in our long-standing approach to principal preservation.

Lastly, our corporate responsibility initiatives are at the forefront of our efforts, and we are always looking for ways to better communicate our progress on key environmental, social and governance objectives. We have added a section in our upcoming 10-K on our human capital, highlighting the measures we take to create a vibrant, team-oriented environment centered on open communication. We will also publish statistics on the diversity of our team, which we think will reflect well on our commitment to equality and inclusion.

Lastly, as always, we remind you that we are internally managed and fully aligned with our fellow shareholders' interest.

With that, I'll turn it over to David to review the financials.

Thanks, Jeff, and good afternoon, everyone. Before we begin, I would like to call your attention to a change in our non-GAAP earnings measure, core earnings, which we have replaced with distributable earnings. This change aligns us with our mortgage REIT peers and with recent SEC guidance. We will be addressing distributable earnings on this call, but please note that except for one item that I will explain shortly, our calculation has not changed from prior quarters when we presented core earnings.

Our operating results are detailed on Slide 12 of our earnings presentation. For the fourth quarter of 2020, we reported total revenue of $32.5 million and net income of $22.4 million. On a per share basis, this reflects a GAAP net income of approximately $0.17 per diluted common share. Adjusting for the impact of nonrecurring costs and other noncash items, our distributable earnings for the fourth quarter were $26.2 million or $0.20 per diluted common share.

Interest income on our loans in the fourth quarter was $25.3 million and fee income was $7.2 million. The increase in interest income from the fourth quarter was driven primarily by higher-than-expected collection of interest on the resolution of loans and default status. For the full year 2020, we reported a total revenue of $122.4 million and net income of $90.2 million. On a per share basis, this reflects a GAAP net income of approximately $0.68 per diluted common share. Our distributable earnings for the full year were $99.6 million or $0.75 per diluted common share. Interest income on our loans for the full year 2020 was $93.9 million and fee income was $28.5 million.

Now I'd like to call your attention to 2 accounting items for this quarter. First, we adopted the current expected credit losses, or CECL model in December 2020 with retrospective application for adoption as of January 1, 2020. CECL requires us to evaluate potential credit losses across our entire portfolio, no matter how remote, whereas our prior accounting under the incurred loss model was focused on potential losses on loans and default status. This naturally resulted in an increase in the company's allowance for credit losses. And for the fourth quarter, we recorded a provision for credit losses of approximately $998,000. This is in part a true-up provision as a part of CECL adoption, and we do not expect significant variability in future quarters. Furthermore, this is a noncash item, and we remove it from our distributable earnings as we have in past quarters with core earnings.

In connection with CECL adoption, we added a line item to distributable earnings for realized credit losses on loans, where we did not recover the full amount of principal outstanding at the time the loan was repaid. This is a change in treatment from our historical calculation of core earnings. For the fourth quarter, realized losses were $189,000, representing approximately 2 basis points on the total principal amount of our outstanding loan portfolio.

Second, our compensation expense of $6.1 million for the fourth quarter reflects the combination of added personnel and regular end of year costs. As we've previously stated, we have made substantial progress on internalizing our legal and corporate functions, and we expect that the increase in compensation expense will be more than offset by cost savings in professional fees and G&A beginning in 2021. We continue to expect to see a total compensation and G&A cash expense run rate of less than $6 million per quarter for 2021, which reflects the success in further internalization.

With regard to origination volumes, which are presented on Page 5 of the earnings presentation, in the fourth quarter, our risk-reducing amendments and originations reached a total value of $194.8 million. As Jeff mentioned, this exceeded many of our quarterly volumes prior to the COVID-19 pandemic, and we expect this pace to moderate somewhat as we start the New Year. We reiterate that origination volumes may still vary from quarter-to-quarter based on the timing of loan closings, but we believe that our recent capital structure enhancements will provide us with greater origination capacity over the long term.

With regard to our portfolio credit, we continue to work with borrowers to address the legacy defaults resulting from COVID-related delays. As we have previously stated, this will take some time, but we are very confident in our ability to generate positive economic outcomes, given our historical track record and our low LTVs. We expect to provide further updates in the near future, and we remind you that the earnings drag of approximately $0.03 per quarter of distributable earnings per share resulting from loans on nonaccrual status should continue to decrease as resolutions are achieved.

Now turning to our balance sheet. As detailed on Slide 11 in the earnings presentation, we had no debt and $223.4 million of cash as of December 31, 2020. While we are seeing a very competitive landscape, we believe our liquidity position is well as we work through our current pipeline, which is in the range of $200 million to $250 million.

Next, I want to take the opportunity to comment on 2 developments that we believe will help us unlock exciting new growth potential. First, as Jeff touched on earlier, we recently finalized a $135 million revolving credit facility with a diverse syndicate of leading banks. While we've historically operated without debt, we believe this modestly sized credit facility will enable us to optimize our cash management, allowing us to deploy a greater percentage of our existing cash. More specifically, we expect that this facility will allow us to reduce our cash balance by approximately $100 million over the coming quarters as we fund additional loans and grow our business. Second, we filed our shelf registration statement in January 2021, which gives us additional capital optionality and increased financial flexibility.

Let me provide some additional context on new loan originations and the premium yields we produce. Broadmark's loans typically range 14% to 16%, inclusive of interest and fees. Given the short-term nature of our loans and the urgent demand for housing construction, we are confident that we can continue to put capital to work effectively. Furthermore, another area of distinction is that we are fully aligned with shareholders, given that we are internally managed. This alignment helps to ensure that we will raise capital only when the time is appropriate.

To conclude, as we look ahead, I want to reiterate the set of principles we laid out last quarter, which we believe will allow us to achieve our goal of significant growth in a manner that is incredibly accretive to our shareholders. Those principles are as follows: maximize earnings on our currently deployed capital through the continued resolution of loans and contractual default; maximum deployment of existing capital with the credit facility now in place; ensure sufficient operating capital available for deployment through our various sources, including through our recent shelf registration statement; and finally, identify opportunities for new earnings power and growth.

Now I'd like to turn the call back to Jeff for a few closing comments.

To recap, we are proud of our achievements in the challenging environments in 2020, and we want to extend our deepest gratitude to our team members, shareholders and other partners for your continued support. Over the past year, we've made significant progress in continuing to enhance our capital structure to provide optimal flexibility, leaving us well positioned to execute as we look ahead into 2021 and beyond. We're very excited of the opportunities that lie ahead as we continue to focus on origination activity and meet the demand for much needed housing construction.

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

(Operator Instructions) Our first question is from Randy Binner from B. Riley Securities.

This is Cullen Johnson from B. Riley. I am on for Randy this evening. First, I just wanted to ask on the new credit facility. I think you mentioned it will reduce -- you might reduce your cash balance by about $100 million in the coming quarters. Does that kind of imply a line on the revolver for a similar amount of liquidity to replace that? Or is it thinking kind of take that balance sheet cash down but then draw a smaller amount on that revolver?

Yes. Sure. Thanks, Cullen. That's a great question. And yes, so first, we are very excited to have that credit facility in place announced earlier today. And consistent with our messaging in the past for now and in the near term, that is a straight $100 million off of our current $223 million, or as of December 31 made about $223 million on the balance sheet. So that we kind of view it as the working capital solution. It allows us to hold less of that cash from our balance sheet. And then we'll reevaluate kind of how we use that facility going forward. But I think in 2021, we've got about $100 million cash on the balance sheet that we can deploy into new originations without drawing on the credit facility.

Okay. That makes sense. And then just wanted to ask on the -- I noticed the weighted average LTV and the new originations picked up a little bit in the quarter. Do you think that reflects maybe just a slightly higher risk appetite? Or should we not really read into it that much yet?

Cullen, I'll take a stab, and I'll let Jeff jump in if he has any additional comments. No, I mean, we haven't changed any of our underwriting. I think that might just be a -- this quarter, maybe a little bit of an uptick, but we're standing by our 65% LTVs. We feel confident about the loans we originated in Q4 and weren't really any differences versus the previous quarters when we were originating loans. We felt good, though, that we were able to put about -- over $190 million in the fourth quarter, which is usually impacted by seasonality. So we felt good, but no change in risk appetite.

Cullen, when we go vertical, so building a home, building an apartment, we usually get closer to that 65% maximum of ours. When we are doing land loans, we dropped that down quite a bit. And our -- the portion of our portfolio that has been land, we've been working to bring down. And my guess is that if you did the math, that's where a lot of that would come out. Does that make sense?

Makes sense, yes.

Our next question is from Stephen Laws from Raymond James.

I guess, first, Jeff, as I think about the -- or maybe, David, if you talk maybe from a modeling standpoint, as I think about the pace of near-term repayments versus your origination pipeline, how should we think about growth going up and cash balance down in the coming quarters? And I guess coupled with that, the mix of Mid-Atlantic and Southeast loans has increased a little bit in the last couple of quarters, but I'm a little surprised that it hasn't increased more. So can you talk about expanding into those markets? Is it just having limited capital deployed there as you recycle capital within other regions? Or how should we think about those 2 new regions growing as a mix of the portfolio this year?

Thanks, Stephen for joining. Jeff -- I'll talk a little bit about liquidity, Stephen, and then I'll let Jeff talk a little bit more about the regions. So yes, I mean, we had $223 million in cash on the balance sheet as of December 31. That's obviously a little bit higher than we would have liked to have seen. And I think the driver of that, to your point, I think you mentioned prepayments, we saw almost higher than pre-COVID levels of payoffs. We saw about $169 million in the fourth quarter, which is a little bit higher than our run rate that we would expect. So that kind of offset the significant originations that we did in the quarter. But we feel really good about Q1 and the upcoming quarters, knowing that we basically got free rein to go out and do as much as we want with that significant liquidity and now that we have the credit facility in place. So I don't think there's any necessary changes. It's just continuing to attack that pipeline, put out good loans and take the loans that are in front of us, right? It's residential -- single-family residential is very hot right now. There's a lot of competition there. We're continuing to see competitors enter the market. And we're going to pick our spots and do the best collateral that's in front of us and ultimately ensure that we deploy as much capital as possible in the upcoming quarters.

And I think, Stephen, by the way, nice to hear your voice. Thanks for joining us. I think that you -- I certainly expect to see both the Southeast and the Mid-Atlantic to continue to grow over the course of this year and in the future. The 4 regional guys are very close and very competitive, and I think they all have each other and their sites. So keep an eye on them, and I think you'll see that, that picks up.

Great. Great. And yes, good to be on the call, Jeff. Appreciate the comments. When I think about the timing and resolving the remaining $158 million of defaults. They're typically short-term loans. I'd imagine A, they get resolved fairly quickly compared to maybe some other possible loans. But can you talk about the timing of resolutions here and kind of where you think that it will get to kind of back to a more normalized level? Is it -- where is that from where we are today at $158 million?

Sure. Yes. And I would say, Stephen -- so I think in Q4, we reduced our total defaults outstanding by about 10% from Q3. So not -- we'd love to be doing 20% a quarter. I think 10% was a good run rate for Q4. We're trying to attack a similar rate in Q1. But I think to your point, yes, I think 70% of the loans in the current default portfolio are complete or nearly complete. 67% of that is collateralized by residential properties. So we feel good about those numbers. They just do -- we're still catching up on some of those. So it will take a little bit more time. I think our goal is to get to a normalized run rate in 2021. It's not going to be the first quarter. Obviously, if we're at -- I think we're at 13% default rate right now, that's not where we want to keep, bring that down with the goal of kind of having a normalized rate by the end of 2021. But I think we did -- we made good progress. You saw the pickup in earnings based off of the default resolution. I think we dropped our loans on non-accrual status pretty significantly, probably by about $30 million or $40 million, and that's the driver for the pickup in some of the interest income. So we're working on that $0.03 drag. We dropped it from $174 million of nonaccrual at September 30 to about $127 million as of December 31. So it's not happening as quickly as we'd like, but we're continuing to get some defaults out. We had 4 total defaults in Q4 plus 3 that were in default status we bought back current. So we're just chipping away, continuing to bring that drag on earnings down and just finding the best economic outcome that we can for each individual loan and default, which has been successful to date. We continue to get principal and interest on most, if not all loans on resolution. So there's always going to be some heavier loans that takes a little bit more time, and those are the ones that you'll see us working through in 2021.

Great. Last question, I want to touch on the private REIT. It looks like another good month of growth from the newsletter a few days ago. Is this a pretty good pace that you feel good about? It seems like the last 4 or 5 months have been pretty solid growth there that have picked up over the first 5 or 6 months of the fund?

Yes. Stephen, we've seen a lot of interest. We've really picked up the pace in the last 3 or 4 months. I think we were at $74 million fastest under management as of January. So obviously, that a long time coming from March when we launched the private REIT in the middle of the pandemic. So definitely positive pickup there. At the current state that we're at and in the current environment where we've got a ton of cash on balance sheet and we're working through that, we're going to evaluate each month how much capital we want to bring in from the private REIT. We've got a lot of interest. We've got some folks in the pipeline looking to get involved in the private REIT. So we'll continue to evaluate what's the best source of capital. I think we have the luxury now between the registration statement, the credit facility that allows us to free up cash. We've got kind of a giant toolbox of different tools finally that we can use to source capital when we need it. But I think right now, the top priority is just making as many loans and dropping that cash balance down now that we've got the credit facility in place. But we'll continue to monitor the private REIT. And there's -- it's -- we're happy to say that there's significant interest, and it's come a long way.

Our next question is from Steve Delaney from JMP Securities.

David, if I may start with you, on the new revolver, nice accomplishment on that. It's referred to as a secured facility. Can you just comment on -- generally on how it might be secured with respect to either specific assets? Or is it more of a blanket lean type of a thing?

Sure. Great question, Steve, and thanks for joining. Yes, it's the latter. It's more of a -- it's a blanket lean on the equity in the company. So there's not individual leans being taken on our loans, and it's covered in the equity of the company. And that was important to us. And I think our lenders were incredibly supportive and helpful in finding a solution that makes sense for us. There aren't a ton of mortgage REITs out there that have credit facilities that are kind of a revolving credit facility like this. And this was optimal for us. It just made sense because we carry so much cash on our balance sheet to get something that's flexible that allows us to draw as needed and really just use it as that working capital solution where we can just free up significant cash and put that out in new loans.

Great. It sounds like it's a lot of flexibility. You're not having to move assets around and pledge assets. It seems basically, they're just standing and not that -- in a disaster situation -- you guys voluntarily decided for whatever reason you were going to liquidate, they would just stand ahead of your common shareholders, right? And that will be paid in full and then the shareholders get everything else. So that's a great.

And Jeff, one for you. I noticed -- I don't read everything comes across my desk. I just -- I wish I could, but I finally found something to read on Tuesday. FHFA put out the home price increases for February -- for year-over-year. So this was for the fourth quarter. And 4 of the -- the top 4 states in terms of HPA, all with year-over-year home price improvement in fourth quarter were Idaho, Montana, Utah and Arizona. So you guys are in 3 -- your mountain region. You're in 3 of those 4, except for Montana. Obviously, not a large state population, but is the situation there one of where is it a judicial state? Or is there simply just not enough population density in any one particular market to support a presence?

You're referring to Montana?

Yes. Referring to Montana, yes.

So Montana is a state that we have on our radar, and it is small. And it's pretty easy for Montana to grow quickly because it's starting with us -- it depends on the size of the numerator as well as the denominator, right? And so -- but it's a good state. It sort of reminds me of Idaho when we went in there. And we will look at it. We'll look at other markets, and we'll do it cautiously. And home price is all over, Steve, have just been strong. There's one to use.

Well, and it just shows there are multiple investors, I'm sure, when you get a defaulted or troubled property. There are people looking for that, right? They don't want to pay full freight buy the property, and if they can do a little private buy something that's 80% done and improve it, that's great value for a potential homeowner. So...

Yes. And the tough part, Steve, is that there's -- every month, every quarter, there's another headline about one place or another. And we tend to stay focused on what we do, and it served us pretty well for the last decade or so. And so before we just jump on whatever the next hot spot is, we want to make sure that we do it methodically, and we do it with the same rigor that we always have.

This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you. Thank you all for being part of this call. It's exciting to have our first full year under our belts. We couldn't have done it without all of you. And on behalf of all of us at Broadmark, I'm grateful. I hope that you all stay healthy, and I look forward to speaking with you again, if not before, at the end of next quarter. Thank you.

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