Broadmark Realty Capital Inc (BRMK) 2020 Q3 法說會逐字稿

Greetings, and welcome to the Broadmark Realty Capital Third Quarter 2020 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stephen Swett. Thank you. Mr. Swett, you may begin.

Good afternoon. Thank you for joining us today for Broadmark Realty Capital's Third Quarter 2020 Earnings Conference Call. In addition to the press release distributed this afternoon, we have filed a supplemental package with additional details on our results, which is available in the Investors section on our website at www.broadmark.com.

On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. A number of factors could cause actual results to differ materially from those anticipated.

Forward-looking statements are based on current expectations, assumptions and beliefs as well as information available to us at the time -- at this time and speak only as of the date they are made, and management undertakes no obligation to update publicly any of them in light of new information or future events. Additional information about the factors that may affect the company's operations and results is included in the company's annual report on Form 10-K for the year ended December 31, 2019, and the company's other SEC filings.

During this call, we will discuss 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'll turn the call over to Jeff.

Thank you, Steve, and welcome to our third quarter 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 third quarter performance and provide some insight on the attributes that differentiate Broadmark from many other commercial real estate lenders or CMBS investors. Then I'll turn the call over to David to provide additional detail on our financial results and performance, loan portfolio and our industry-leading, no-debt balance sheet. We will then open up the call for your questions.

For the third quarter, we originated $153 million of new loans, bringing our year-to-date originations to over $313 million. We're very pleased with the pace of originations, which accelerated through the third quarter. This level of originations is more in line with our historical pace prior to the COVID-19 pandemic. We believe that this return to a more normal cadence reflects not only the strong housing fundamentals, which I will elaborate on shortly, but also Broadmark's exceptional balance sheet and liquidity position.

Unlike other highly leveraged lenders, we retained a strong cash position throughout the early months of COVID when construction activity slowed, allowing us to get back into the market quickly and take advantage of lending opportunities where our competitors were forced to pull back. We currently lend in 14 states plus the District of Columbia. We selected these states due to favorable demographic trends, which have continued to drive demand for residential construction even throughout the COVID-19 pandemic. We believe the demographic trends in these states will remain strong well into the future.

A great example of how we are winning new business and gaining market share is our Southeast and mid-Atlantic regions. These regions are relatively new growth markets for us. And as depicted on Slide 7 of our earnings presentation, they make up a smaller percentage of our portfolio today as compared to the Pacific Northwest and Mountain West regions. We expect to see strong growth in the Southeast and mid-Atlantic regions over the coming years as we demonstrate ourselves to be reliable lenders, offering unparalleled speed and certainty of execution, just as we have done in our markets in the West.

As we continue to grow and diversify our portfolio, we are also able to fund larger projects, which both improves our margins and helps to expand our market share. As an example, we recently underwrote a loan on a residential project in Nashville. This is a 21-month loan on a 132-unit multifamily project, and the borrower is a new Broadmark customer with excellent credit in over 40 years of experience in construction. We won this loan due to our growing reputation, scale and financial capacity. Even better news is that we were able to win this business without sacrificing our historical pricing structure.

As construction lenders, we are providing capital to fund projects under development. But we are not providing the long-term financing that is dependent on cash flows from future rent. This is a key differentiator between our business model and those of longer-term financing providers and CMBS investors. The short-term nature of our loans means that we can identify attractive lending opportunities in the immediate term in markets where there is high demand for construction loans. As long as builders are active in those markets and we remain confident in the strength of the underlying demographics, we can provide the capital to complete their projects. If certain markets become less attractive over time, we can pivot our lending efforts to other cities or regions without being reliant on cash flows from finished projects over the long term.

The one constant that is shown on Slide 8 of the presentation is that through almost all economic cycles, home building tends to have relatively stable demand. Compared to other property types, the pandemic has not, in any way, diminished the need for residential construction in our high-growth markets. And in many ways, COVID has exacerbated the housing supply shortage due to construction and other delays. For this reason, we believe that our portfolio and lending focus is better suited to generate attractive and consistent returns than many of our commercial mortgage REIT peers.

Another key differentiator between Broadmark and other commercial real estate lenders relates to the types of projects we fund. We have little exposure to urban office buildings, malls, high-rise residential or other property types that have declined in value as a result of the pandemic's near-term and projected long-term effects. Our portfolio is 58% residential loans, comprising mostly single-family and small multifamily development. We have another 16% of our portfolio comprised of loans for horizontal development, again, primarily for residential properties, which also gives us the option of whether or not to fund the later construction on the finished lot.

Less than 20% of our portfolio is classified as commercial loans and reflects a diversified pool of small office, retail and hotel properties. While we have been opportunistic with these commercial loans, over time, we expect this category to decline. The remaining 7% consists of land, which has also been a declining category for us over time as we have transformed many of our land investment into vertical construction, which has helped to further derisk our portfolio.

Compared to our peers, we also have 2 unique characteristics. First, we are internally managed, which provides for the full alignment of interest between management and shareholders, allowing us to focus on maximizing value creation rather than generating management fees. This is in stark contrast to most publicly traded commercial lenders, which are externally advised.

Second, we have strategically operated without leverage in an industry where most of our competitors are highly leveraged. We believe that maintaining a strong balance sheet is critical to operate effectively throughout market cycles. In the recent period of market distress, this approach has allowed us to demonstrate our reliability and to grow our market share as many of our credit-dependent competitors have been forced to pull back, leaving their borrowers without financing. We've not had to do so, and as a result, our reputation as a reliable lender that stands by its commitments has continued to grow.

As we approach our 1-year anniversary as a public company, I reflect on the changes and enhancements we've made to our organization over the past year. To help address the new challenges and opportunities of public company life, we have strengthened the management team by adding David Schneider as our CFO; and Nevin Boparai as our Chief Legal Officer. We also promoted Linda Koa and Daniel Hirsty, 2 Broadmark veterans with tremendous experience and proven capabilities, to the positions of Chief Operating Officer and Chief Credit Officer, respectively. Furthermore, we are supported by a Board of Directors who bring irreplaceable strategic guidance in real estate and public company expertise to our efforts.

In many important ways, however, little has changed. We continue to apply the same rigorous underwriting standards that have minimized our loan losses, which, as a reminder, have been less than 1/2 of 1% over our 10-year history.

We've grown our team by over 20% since going public while maintaining the culture that has contributed to Broadmark's success over the past 10 years. And despite the physical distance imposed by COVID we feel we've been able to enhance that culture through our weekly all-hands video calls, regular team check-ins and virtual company events. For instance, since we couldn't hold our annual summer barbecue in person, we decided to have barbecue dinners delivered to everyone's home this year, and we had a virtual company party over Zoom.

Lastly, we maintain the same commitment to corporate responsibility that we've had since our inception. As we look ahead to the year-end, in lieu of an elaborate holiday celebration, we are planning to make a contribution in each of our employees' names to Restaurants For The People. This is a charity that purchases meals from local restaurants to provide to homeless shelters, helping the restaurants retain staff while also providing for those in need, which seems like a fitting way to express our support.

We regard these social responsibility initiatives as a central part of our company culture, and we look forward to providing further updates on our environmental, social and governance or ESG initiatives as we continue to enhance our disclosures. And as a reminder, with regard to our governance practices, the management team at Broadmark is uniquely aligned with investors as we are internally managed and management retains significant ownership in the company.

I'll now turn it over to David, who will review our financial results in more detail.

Thanks, Jeff, and good afternoon, everyone. Our operating results are detailed on Slide 12 of our earnings presentation. For the third quarter of 2020, we reported total revenue of $29 million and net income of $23.2 million. On a per share basis, this reflects a GAAP net income of approximately $0.18 per diluted common share. Adjusting for the impact of nonrecurring costs and other noncash items, our core earnings for the third quarter were $23.3 million or $0.18 per diluted common share. Interest income on our loans in the third quarter was $21.8 million, and fee income was $7.1 million.

With regard to origination volumes, which are presented on Page 5 of the earnings presentation, in the third quarter, we originated 22 loans with a total value of $153 million. As Jeff mentioned, this is in line with our historical quarterly rate prior to the COVID-19 pandemic and reflects regained momentum from the second quarter when we slowed originations during the height of the lockdown measures. Importantly, 97% of our third quarter originations were for residential development, where we currently see outsized growth opportunities.

We would reiterate that origination volumes may still vary from quarter-to-quarter based on the timing of loan closings and seasonality of the construction business, but we feel great about the pipeline of opportunities in front of us. Additionally, as a reminder, the full earnings benefit of origination in any given quarter will be realized over time as our accounting treatment requires that origination fees be recognized over the life of the loan.

Now turning to our balance sheet. As detailed on Slide 11 in the earnings presentation, we had no debt and $173.6 million of cash as of September 30, 2020. We believe our liquidity positions us well as we work through our current pipeline, which exceeds $230 million, and we are encouraged by the normalization of borrower activity we've seen in recent months.

Also, as we have previously communicated, we intend to put a modestly sized working capital credit facility in place in the near future to more efficiently manage cash. While this is a change from our historical approach, we believe it is appropriate as a tool to help us grow our portfolio and ultimately our cash flow and dividends. In addition, we become shelf-eligible on December 1, which will provide incremental opportunities to strengthen our capital structure.

Next, I'll provide an update on defaults. As a reminder, the majority of our existing contractual defaults entered into default status in March and April at the outset of the pandemic as certain states implemented temporary construction halts. Since then, we've worked diligently to resolve these defaults.

Historically, we have cured the vast majority of our defaults without foreclosure and with no principal or interest loss. Excluding 5 loans in forbearance, as of September 30, we had 30 loans in contractual default, representing $194.4 million in principal balance outstanding. During the 3 months ended September 30, 2020, we resolved 6 loans in contractual default and limited new contractual defaults to 1 compared to 8 and 17 new contractual defaults during the 3 months ended June 30 and March 31, 2020, respectively.

Every loan in contractual default status has been evaluated for potential losses and our reserve for estimated loan losses decreased from $6.8 million at June 30 to $6.1 million at September 30, as a result of our differentiated approach to loan workouts. The remaining estimated losses represent only 3% of loans currently in default status and less than 1% of our total portfolio. We estimate that our loans in contractual default have resulted in a drag of approximately $0.03 on our core earnings per diluted common share for the third quarter since a subset of loans in contractual default have been placed on nonaccrual status and we are not recognizing interest income on those loans.

We remain committed and focused on resolving these defaults. Importantly, we expect minimal, if any, losses in a majority of cases and often expect to collect outstanding interest income upon exit in the upcoming quarters.

Finally, our private REIT participated in 22 loans in the third quarter for a total participation of $15.9 million as of September 30, 2020. We view our private REIT as a unique offering, which gives us another source of capital to fund loans while expanding our universe of potential investors to those who prefer a private investment vehicle.

As we look to the fourth quarter and 2021, we are focused on a set of principles that 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: one, maximize earnings on our currently deployed capital through the resolution of loans in contractual defaults; two, employ maximum deployment of existing capital with the credit facility in place; three, ensure sufficient operating capital available for deployment through upcoming shelf eligibility and continued growth in the private REIT; four, identify opportunities for new earnings power and growth.

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

Thanks, David. To recap, we are pleased to have ramped up our originations again in the third quarter, resuming a more normal pace of business and winning market share. Although the COVID-19 pandemic is not yet over, our ability to weather the last several months while avoiding the liquidity distress that so many other lenders encountered gives us added confidence in our business model.

Looking ahead, we see no shortage of opportunities in our lending space as the demand for residential construction loans appears as strong as ever, bolstered by a persistent housing shortage as well as record-low mortgage rates. We are pleased to be meeting the demand for much-needed housing and delivering shareholder value in the process as we grow our reputation as a lender of choice.

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

(Operator Instructions) Our first question comes from Randy Binner with B. Riley.

I just wanted to kind of dig in on the $0.03 drag that you called out in the prepared comments. I think you said that was the result of loans in nonaccrual status. I think that was where the reported interest income was short versus our model. So I guess just trying to think through timing on kind of when that would get sorted out, what the recovery there might be and kind of what levers you can pull to, I guess, get back to -- well, be more of a normal run rate interest income on the revenues.

Sure. Yes. Thanks, Randy. That's a great question. And I'll start by saying defaults take time to resolve, and I would remind everybody that Broadmark kind of takes a different approach to resolution, which historically has allowed us to avoid any visible losses and generally be able to collect the full amount of interest outstanding. We hate having a drag on -- a $0.03 drag on them. But the view is if we can take a little more time with certain default, it's going to lead to avoiding foreclosure and generally full collection of all the interest outstanding in the near term.

Approximately 72% of the defaulted loans are either construction complete or nearly complete, and 70% or more are residential-based. So I think we've talked the last couple of quarters, there's always a bit of uncertainty when something get resolved. But I know the cause of most of these going into default was a delay. Most of them had construction that got delayed by either a halt in certain states or people who weren't going to work. And it's not always 100% clear how much the progress was delayed. In certain cases, it was 1 month. In certain cases, it could have been 3 months.

But we're paying attention to each -- each individual loan is a bit unique. I think the good news is what we saw in Q3 was less defaults cleared than we had hoped to. So we still some of that drag on -- still saw that drag on interest income. But the 6 that we did resolve, we collected all the principal outstanding, all interest income outstanding that we hadn't accrued for in the prior quarter. So we got to pick that up, and we think that's the trend that we'll continue to see. We think we can probably close out more upcoming in Q4, sizable not in Q4 and then hopefully most of them in early in Q1 of 2021.

So it's not going to be a pop where 1 quarter all the defaults are gone, but I think we made a lot of progress in Q3. I think it continues to be the top priority for us. I think you'll see probably more in Q4 than we saw in Q3, and then hopefully, really clean it up in Q1. And then we'll hopefully start fresh with -- in 2021.

And I'd say the good news is we're also seeing a trend where we're not seeing new defaults, right? We saw 17 enter default status in March. Clearly, a direct result of the pandemic. We also saw some in April and May where we had 7, and then we saw 1 new contractual default in the third quarter. So we think we're trending in the right direction. In terms of what we deployed, we've executed forbearance agreements where it makes sense. And on those type of loans where we've executed forbearance, we're actively collecting rents, and those are generally reserved for properties that have already been completed and are now income-generating. So we're collecting on those, recognizing those on a cash basis.

But ultimately, it's a delay. Is it going to take years? Absolutely not. Do we know exactly when each loan is going to be resolved? Not always. But we feel good that there's going to be a chunk in Q4 and then it will work our way through Q1. And we feel like 2021, we feel very good about a much smaller default portfolio.

All right. That's helpful. And then I think you said in the script that originations were accelerating in what they were in third quarter but also in the fourth quarter. So just wondering if I heard that right, if you're still seeing a lot of origination opportunity and if you could characterize how the pricing is on those? Meaning, are you seeing other lenders come in and get more competitive or not?

Sure. I'll touch on that a little bit. I'll let Jeff jump in if he has any comments. The pipeline, I think we commented on our pipeline in our deck, is about $230 million. That's typical for us, right? That means it's good enough that we're executing an LOI. We're looking at it. We have a good chance of winning that loan.

Do we always hit our pipeline? No, we don't hit the full pipeline, but we're seeing the same level of interest, especially in the residential space, from borrowers. And we feel good that we're going to continue to get potential deals like -- Jeff talked about the Nashville one. That's -- when we look at the size of that and the term of that, it's longer and bigger than the typical set of loans we do. But the return on our -- the return on our investment for the same level of effort is going to be much greater. So we're looking at those type of deals. There's always competition.

I think we saw -- in prior quarters, we mentioned that some of our competitors were on the sidelines. Some of them have certainly come back, but we don't compete on pricing, and we're still getting the same type of pricing structure and executing on that same type of pricing structure that we historically have.

Well, just one more for me and then I'll jump out of the queue. But just on G&A, I -- understanding that, that line item has been -- I guess it's a little up and down. But it was higher than we had in the model this quarter. So was there anything unusual this quarter that we may not necessarily see in the fourth quarter and quarters beyond?

Sure. Yes. I mean, Randy, I'll tell you, it gives me heartache because first year as a public company, it's very hard to come up with your run rate for G&A just because there's a lot of first year public company expenses that we're incurring, whether that's ensuring our compliance with SOX, whether that's hiring the right people to do SEC filings and other compliance managers. Us, as a target of a SPAC IPO, we certainly have faced a lot of challenges in terms of being immediately public company-compliant. So we've done a great job.

And Jeff mentioned, our headcount has grown by 20%. So we've made a lot of strategic hires that not only are going to aid in compliance and growth, but they are also, over time, to bring down third-party legal accounting, consultant costs -- consulting costs as we become further internalized.

So in terms of G&A specifically in the third quarter, it's generally going to be related to some legal fees, accounting fees related to SOX implementation, consulting fees around some of the new systems we've implemented. So these are things commonly that we're going to view as first-time public company expenses.

I think our compensation and benefits in G&A, it has fluctuated a little bit quarter-over-quarter as these type of third-party expenses have come in. I'd say I think -- if I had to come up with a run rate, I think we've consistently been around $2.5 million in comp and benefits cash and around $3.5 million a quarter in G&A expenses. But again, there's some bumpiness and lack of smoothness quarter-over-quarter just because of the nature of some of these expenses.

I would say I think when we adjust for a lot of the first year public company expenses, which we do within our core earnings, our non-GAAP measure in the 10-Q and the MD&A as well as in our earnings release, that number comes down probably closer to $5 million to $5.5 million of cash expenses for comp and benefits in G&A, which is probably a more reasonable expected run rate for future quarters. So I think we'll continue to see some noise in Q4, but I think every quarter that we have our new headcount and we further internalize by doing some strategic hiring, you'll start to see the G&A continue to come down. And I think we'll clearly see the full benefit in 2021 when we fully transition responsibilities to our employees as opposed to third party.

Our next question comes from Stephen Laws with Raymond James.

To follow up on Randy's question, kind of moving from cash expense to noncash comp. It looks like it doubled to about $2 million after running about $1 million a quarter in the first half of the year. Can you give us some -- an idea of what caused the increase this quarter and what the right level of noncash comp is going forward?

Yes. So I think there was a little bit of noise with some new RSU grants, a catch-up on some RSU grants in Q3 amortization. I think the run rate is probably closer to what we saw in Q2. It's probably a blend of 2. Somewhere around $1 million, I believe, is what we are running at quarter before. And that's really amortization of RSUs that have been granted to executives, officers, employees. That will start to come down. The employees have fully vested as of a few days -- as of November. So that will come off. And then you'll just have some of the officers and executives, including some of the new officers that we've hired this year.

So I think you'll start to see a normalized run rate. Q3 was higher than you'll see in Q4, just for a catch-up on some of the RSU expense. So it's probably closer somewhere to a little bit higher than what you saw in Q2. So it's probably coming in around $1 million or so.

Okay. Great. And then to circle back to Randy's first question on the top line. We've got a positive benefit from the new originations on interest income. You still got the nonaccruals, but that's firming up. Are we going to see interest income positive sequentially from 3Q? Or do you think there's still some pressure to come from maybe nonaccruals that started late in the third quarter?

Yes. I mean we feel -- the one thing I would say, Stephen, that's the hardest part, is there's always some uncertainty around something could change and push a default 1 month later than you expected. It could also -- less so often happens 1 month earlier, but we hope for that in some cases. But no, we fully expect to have some defaults resolved somewhere resolved in October. We expect to see a good chunk in November. And if that does happen and nothing out of the ordinary happens, we're trending in all the right directions.

I think that's the important point. We're not seeing new defaults come in. So as long as nothing changes in the construction business or the market and there's no new default, we fully expect to clean up a chunk throughout Q4, which actually will increase of interest income. So we feel good about where we came at $0.18 sort of consensus estimate. It was purely driven by interest income for the most part. So we feel we'll be able to pick that back up beginning in -- each quarter, we'll get a pickup, I think. As we resolve the default, we'll directly see an impact to interest income.

So again, it won't be a pop. They won't all be resolved at 12/31, but we'll get a chunk out in Q4, and then we'll get to that in 2021.

Great. And switching gears to the private REIT, I think the Q has $15.6 million listed, but AUM and 8-K back at the end of August was $18.5 million. So did AUM decline in the private REIT during September? Or are those not comparable numbers?

Those are not comparable. I think $15 million was for the 3 months ended 9/30. I think the total is -- AUM is about closer to $38 million as of September 30. And then we've been very productive in Q4, thus forth -- thus far. So we feel like that number is going to pick up, and you'll see some traction in Q4. That brings it even higher. But yes, Stephen, that number is, I think, for the 3 months ended. We raised $15 million, and I believe the total number like to date since March is closer to about $38 million now.

Okay. So September, then you raised roughly $20 million. Is that right?

No. September, we had -- about $15 million, I believe, is the exact number. But I could be overstating the $38 million number, but the $15 million is for the third quarter.

Great. I appreciate the correction there. I was not looking at comparable numbers, so that's helpful. Let's see what else I want to hit on. CECL, in the Q, you mentioned you're going to adopt CECL, I believe, in Q4. And you'll have to adopt it for the full year 2020 period. Did I read that correctly? Or can you give us any additional color on CECL adoption, timing? And is it correct that you'll adopt for both Q4 and for full year 2020?

That is correct. So we started the year even as an emerging growth company. We had EGC status due to our size and growth involving trading volume and other assets. We're losing that EGC status as of year-end. So we're adopting it for -- in December for the full year.

I think the good news is -- and we fully expected this, given the short-term nature of our loans, given that they're fixed rate. We're already in the process of implementing. We have preliminary results from our models, and we're very confident that any impact to financial statements will be immaterial. I think the thing we've been focused on as we implemented it is the uniqueness of our portfolio based on the term loans, the fixed rate nature.

So we're just trying to implement a solution for CECL that is auditable and compliant and not causing a huge loss for the company, something that we can maintain. And we're almost there. We feel good about that. And I guess the key takeaway is we're not expecting any significant impact to our current level of reserves.

There are no further questions at this time. I'd like to turn the floor back over to management for any closing remarks.

Thank you all for listening today. Thank you all for your support. Randy, it's nice to meet you. I'm sorry that David got to answer all the questions today. Stephen, thanks for your support. And you all know how to find us if you need us. And stay safe, stay healthy, enjoy your holidays, and we'll talk soon.

Thanks, everyone.

Ladies and gentlemen, this concludes today's web conference. You may now disconnect your lines at this time. Thank you for your participation, and have a great day.