Q3 2020 Broadmark Realty Capital Inc Earnings Call
Greetings and welcome to the broad Mark Realty capital third quarter 2020 earnings call.
At this time all participants are in a listen only mode.
A brief question and answer session will follow the formal presentation.
If anyone should require operator or technical assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Stephens what.
Thank you Mr. Swett you may begin.
No. Thank you for joining us today for Broadsmart Realty Capital's third quarter 2020 earnings Conference call. In addition to the press release distributed this afternoon, we filed a supplemental package with additional details on our results, which is available in the Investor section on our website at Www Dot <unk> Dot com.
Today's call management's prepared remarks and answers to your questions may contain forward looking statements.
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.
These 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 31st 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 FCC filings.
This conference call is hosted by broad marks Chief Executive Officer, Jeff <unk> our.
Our Chief Financial Officer, David Schneider management will make some prepared comments after which we will open up the call to your questions now.
Now I'll turn the call over to Jeff.
Thank you, Steve and welcome to our third quarter Twentytwenty earnings call.
We hope that all of you and your families remain safe and healthy.
This afternoon I'll begin by discussing our third quarter performance and provide some insight on the attributes that differentiate broad market and 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 broad marks exceptional balance sheet and liquidity position.
Unlike other highly leveraged lenders, we retained a strong cash position throughout the early months of Covance when construction activity slowed, allowing us to get back into the market quickly and take advantage of lending opportunities for our competitors were forced to pull back.
We currently London, 14 States plus the district of Columbia.
We selected these states due to favorable demographic trends, which continue to drive demand for residential construction.
Even throughout the quarter with 19 pandemic.
We believe the demographic trends in these states will remain strong well into the future.
Great example of how we are winning new business and gaining market share as our southeast and mid Atlantic regions.
These regions are relatively new growth markets for us.
Depicted on slide seven 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 be reliable vendors.
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're also able to fund larger projects, which both improves our margins and helps to expand our market share.
As an example, we recently underwrote alone on a residential project in Nashville.
21 month loan.
The 132 unit multifamily project.
And the borrower as a new broad mark customer with excellent credit.
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.
Its construction lenders, we are providing capital to fund projects under development, but we are not providing the long term finance 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 medium term in markets, where there is high demand for construction loans.
As long as builders are active in those markets. 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 overtime, 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 is shown on slide eight of the presentation is that through almost all economic cycles homebuilding 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 Mark.
And in many ways cobalt 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 Broadsmart and other commercial real estate lenders relates to the types of projects we fund.
We have little exposure to urban office building malls high rise residential or other property types that have declined in value as a result of the pandemics 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 overtime, we expect this category to decline.
The remaining 7% consists of land, which has also been a declining category for us overtime as we have transformed many of our land investment into vertical construction.
Which has helped to further de risk our portfolio.
Compared to our peers. We also had two 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 a strategically operated without leverage in an industry, where most of our competitors are highly but.
We believe that maintaining a strong balance sheet is critical to operate effectively throughout market cycles.
In the recent period of market distress. This.
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.
Leaving their borrowers with that financing.
We've not had to do so.
And as a result, our reputation as a reliable lender. It stands by its commitments has continued to grow.
As we approach our one 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 never in bulk or I as our chief legal officer.
We also promoted Linda Coa and Daniel her Steve.
To broaden our 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 and real estate public company expertise to our efforts.
In many important ways. However, little has changed we continue to apply the same rigorous underwriting standards that minimized our loan losses, which.
Which as a reminder have been less than one half of 1% over our 10 year history.
We've grown our team by over 20% since going public while maintaining a culture that has contributed to broad market success over the past 10 years.
And despite the physical distance imposed by code that we.
We feel we have been able to enhance that culture through.
Through our weekly all hands video calls right.
Regular team check ins and virtual accompany events.
For instance, since we couldn't hold our annual summer barbecue in person, we decided to have barbecue dentists delivered to everyone's home. This year and we had a virtual accompany party over zone.
Lastly, we maintain the same commitment to corporate responsibility that weve had since our inception.
As we look ahead to the year end in lieu of an elaborate holiday celebration.
We're planning to make a contribution in each of our employees names to restaurants for the people.
This was a charity the purchases meals from local restaurants to provide the homeless shelters.
Helping the restaurants retain staff.
While also providing for those in need but.
It seems like a fitting way to express our support.
We regard these social responsibility initiatives as a central part of our company culture.
We look forward to providing further updates on our environmental social and governance or E.S.G. initiatives.
As we continue to add enhanced our disclosures.
And as a reminder, with regard to our governance practices. The management team at broad Mark is uniquely aligned with investors as we are internally managed management retained 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 18 cents per diluted common share adjust.
Adjusting for the impact of nonrecurring costs and other non cash items, our core earnings for the third quarter were $23.3 million or 18 cents per diluted common share.
Interest income on our loans in the third quarter was $21.8 million and fee income was $7.1 billion.
With regard to origination volumes, which are presented on page five 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 originations 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, any earnings presentation, we had no debt and $173.6 million of cash as of September Thirtyth 2020, we.
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 borrowing activity we've seen in recent months.
Also as we have previously communicated we intend to put a modestly side 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've become shelf eligible on December Onest, 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 implement the temporary construction halls.
Since then we've worked diligently to resolve these defaults.
Historically, we have secured the vast majority of our defaults without foreclosure and with no principal or interest loss.
Excluding five loans in forbearance as of September Thirtyth, we had 30 loans and contractual default representing $194.4 million in principal balance outstanding during.
During the three months ended September Thirtyth 2020, we results six loans and contractual default and limited new contractual defaults to one compared to eight and 17, new contractual defaults. During the three months ended June Thirtyth and March 30, Onest 2020, respectively.
Every loan and construction default status has been evaluated for potential losses, and a reserve for estimated loan losses decreased from $6.8 million at June Thirtyth to $6.1 million at September Thirtyth 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 and contractual default have resulted in a drag of approximately three cents on our core earnings per diluted common share for the third quarter since a subset of loans and contractual default has been placed on non accrual status and we're not recognizing interest income on those loans.
We remain committed and focused on resolving these defaults.
Importantly, we expect minimal if any losses in the majority of cases, and often expect to collect outstanding interest income upon exit in the upcoming quarters.
Finally.
Our private party.
Participated in 22 loans in the third quarter.
For a total participation of $15.9 million as of September Thirtyth 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 and contractual default.
Two.
Employee maximum deployment of existing capital with the credit facility in place.
Right.
Ensure sufficient operating capital available for deployment to upcoming shelf eligibility and continued growth in the private right.
For identify opportunities for new earnings power and growth.
Now I would 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.
Assuming 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 distressed that so many other lenders encountered.
This 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.
Ladies and gentlemen, we will now have our question and answer session.
If you would like to ask a question. Please press star one on your telephone keypad.
A confirmation tone will indicate that your line is in the question queue.
For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the star keys.
One moment, please while we now poll for questions.
Our first question comes from Randy Binner with B. Riley. Please proceed with your question.
Hi, good evening happy to be joining your members from our call.
Hey, Tom ready.
Hi, I just wanted to.
Okay dig in on the three cents drag that you called out in the prepared comments I think you said.
That was the result of.
Loans on non accrual status I think that was where the.
Reported interest income was was short versus versus our model. So.
I guess, just trying to think through timing.
On kind of when that would get sorted out what what the recovery there might be.
And kind of what levers you can pull.
Are you on.
Hi, guys get back to will be more of a normal run rate interest income on the revenues.
Sure Yes, thanks, Ryan it's a great question also.
I'll start by saying that defaults take time to resolve.
I would remind everybody that that problem are kind of take a different approach to resolution, which historically has allowed us to avoid any possible losses and generally be able to collect the.
The full amount of interest outstanding.
We hate having to drag on for three cents drag on it.
The view is if we can take a little more time with certain default kind of lead to avoiding foreclosure and generally core collection.
While the interest outstanding in the near term.
Approximately 72% of the defaulted loans during the construction complete or nearly complete.
70% or more our residential base so.
I think we talked the last couple of quarters is always a bit of uncertainty when companies get resolved, but I know the cause of most these going into default was a delay most of them had construction that got delayed by either a halt in service dates or people are going to work.
It's not always.
100% clear how much the the progress with delays in certain cases. It was one month in certain cases, it could have been through the month, but we're paying attention. It's glenn its individual loan its a bit unique.
I think the good news is we.
We saw in Q3 was less in fourth quarter than we had hoped to so we still have that drag on still saw that drag on interest income, but the six 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 weve got to pick that up and we think thats. The trend that will continue to see we think we could probably close out more upcoming in Q4.
Sizable amount in Q4, and then hopefully most of anything really in Q1 of 2021, so it's not going to be a pop. We're one quarter. All the results are gone, but I think we made a lot of progress in Q3.
Continues to be a top priority for us I think we'll see probably more in Q4 than we saw in Q3 and.
That hopefully will clean it up in Q1.
And then will hopefully start crestwood.
I'm 2021, and I think the good news is we're also seeing a trend where we're not seeing a default rate fell 17 entered the calls that is in March clearly a direct result of the pandemic.
Also saw some go in May where we had seven and then we saw one contracts will be Paul.
In the third quarter. So we think we're trending in the right direction in terms of what Weve acquired Weve executed forbearance agreement, where it makes sense.
And on those type of loans, where we've executed for guidance. We're actively collecting rents and those are generally reserved for properties that have already been completed under that income generating so we're collecting on those recognizing those on a passport book.
Hopefully.
The delay is it going to take years, absolutely not but we know exactly when these loans is going to be resolved.
Not always but we feel good that there's going to be a chunk in Q4, and then we'll work our way through Q1, and we feel like 2021, the world will feel very good about a much smaller default.
All right. That's helpful. And then I think you said in the script that originations were accelerating.
And whatever in third quarter, but that also in the fourth quarter. So just wondering if if I heard that right. If you're still seeing a lot of origination opportunity and if you could characterize how the pricing pricing is on those meaning are you are you seeing other lenders come in and get more competitive or not.
Correct I'll cut some a little bit I'll, let Jeff jump in if you have any comment.
The pipeline I think we commented our pipeline in our deck, but 230 million. That's typical for US right with that you know that means it's good enough that were executing an ROI. We're looking at it we have a good chance of winning that loan.
We always hit our pipeline of no we don't get 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 that Jeff talked about the Nashville, one, but when you look at the size of that and the term of that.
Longer bigger than the typical sort of loans, we do but.
The return on our on the.
Turn on our investment in to the same level of effort is going to be much greater.
So we're looking at those type of deals there is always competition I think we saw it in prior quarters, we mentioned that some of our competitors are on the sidelines.
Some of them have 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 type of pricing pricing structure that we historically have.
Well just one more from me and then I'll I'll jump.
Out of the queue, but.
Just on DNA I.
Understanding that that line items Ben.
You know it.
I guess, it's a little up and down.
Yes.
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 quarterly guidance.
Sure, Yes, I mean really I'll tell you that it doesn't hurt it because of as first year as a public company, it's very hard to come up with your run rate for DNA differences.
There's a lot of first year public company expenses that were incurring whether that's ensuring our compliance with sox, where that youre hiring the right people to do that thinking filings and other compliance matters.
Losses, as a target of a stock IPO.
We certainly have a lot of challenges in terms of being immediately publicly public company compliance. So we've done a great job and you know, Jeff mentioned or head count has grown by 20%.
We've made a lot of strategic hires I know not only going to eat in compliance and growth, but they're also overtime going to bring down third party legal accounting consult call.
On costs.
As we become further in time internalized so.
In terms of DNA, specifically in the third quarter. It 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 have implemented. So these are things commonly that we're going to view it.
First time public company expenses.
I think our compensation of benefits and DNA 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.
You know I think we've consistently been around 2.5 million in comp and benefits cash and around.
25 million a quarter in DNA expenses.
Again, there is there is some bumpiness and lack of sort of quarter over quarter, just because of the nature of some of those expenses I would say I think.
When we adjust for a lot of the first year public company expenses, which would be within our core earnings are non-GAAP measures.
Thank you and one DNA as well as in our earnings release that number comes down probably closer to five to five and a half.
Cash expenses for.
Comp and benefits and DNA, which is probably a more reasonable expected run rate.
Your quarters. So I think we'll continue to see some some noise in Q4, but I think every quarter that we have our new head count.
Other internalize.
By doing some strategic hiring you'll start to see became a continued to come down and I think we'll probably see the full benefit in 2021, when we fully transition responsibly responsibility to our employees as of course, the third party.
All right great. Thanks, a lot.
Okay.
Thank you.
Our next question comes from Stephen Laws with Raymond James. Please proceed with your question.
Hi, Thanks, good afternoon.
Follow up on Randy's question kind of moving from Cas expense to two non cash comp, but it looks like it doubled to about 2 million after running about a million a quarter.
The first half of the year can you give us some idea of what caused the increase this quarter and what the right level of non cash comp those going forward.
Yes. So I think there was there was a little bit of noise with the new RSU Grant a catch up on some some RSU grants in Q3 and you.
Amortization I think the the run rate is probably closer to what we saw in Q2 with couple of blended with use of around 2 million I believe is what we are running at.
Accordingly, and that's that's really amortization of our Cds that have been granted to executive offices employing.
That will start to come down the employees have fully invested.
As of a few days as of November.
So that will come off anyway.
And then they'll just have some of the officers and executive including the new officers that we've hired bill here. So.
So I think you'll start to see a normalized run rate Q3 with higher.
Then you'll see in Q4 contracts for a catch up on some of the RSU expense, so its probably closer somewhere.
Little bit higher than what you saw in Q2 with us probably coming in more than a 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 the new originations on interest income still got the non accruals, but that's firming up are we going to see interest income positive sequentially from Threeq two or do you think there is still some pressure to come from.
Oh, maybe not accruals that started late in the third quarter.
Yeah, I mean, we feel.
The one thing I would say even that the hardest part of because there's always some uncertainty around.
And could change and puts a default one month later than you expected. It could also let let's though often happens one month earlier, but we hope for that in some cases, but no. We we fully expect.
There has to be faults resolved.
Somewhere of resolve in October we expect to see a good chunk in November.
And if that does happen and you know that.
Nothing out of the ordinary happens we're trending in all the right direction, but I think thats important when you're not seeing new defaults coming on so.
As long as no nothing changes in the construction business or in markets and there's no new default, we fully expect to clean up throughout.
Throughout Q4, which snack.
In 2015 from that.
Good about.
Where we came out and then sort of consensus estimate.
Was purely driven by interest income grew apart so.
Well, we'll be able to pick that back up beginning in each quarter, we'll get a.
I'll pick up I think as we resolve the default.
[noise] directly seen impacted interest income so again it won't be a pop they will all be resolved that property.
We'll get a chunk out in Q4, and then we'll get 2020.
Okay, great and switching gears to the private read I think the Q has 15.6 million listed but are you I'm an 8-K back at the end of August was 18, and a half million. So today you have declined in the private REIT. During September are those not comparable numbers.
Doesn't those are not going to I think 15 with for the three months ended 930, I think the total A.O. Smith about closer to 38 million as of September Thirtyth, and then we've been very productive.
In Q4, that's four thus far so we feel like that number is going to pick up and you will see.
And traction in Q4 that frankly, even higher but yes, given that that number is I think for the three months ended.
We raised 15 million.
And I believe the total number life to date since March is closer to about 38 million though.
Okay. So September then you raised.
Roughly 20 million is that is that right.
Yes September we had oh about.
Hi, Brian.
Exact number.
I could be overstating, the 38 number but the 15 to the third quarter.
Great I appreciate the question there is not looking a comparable number so that's helpful.
See what else I want to hit on Cecil an acute mentioned you're going to adopt Cecil I believe in Q4, and you'll have to to adopt it for the full year 2020 period did I read that correctly or can you give us any additional color on Cecil adoption timing.
And is it correct that it's for both you will adopt for both Q4 and for full year 2020.
That is correct.
So we started the year, even as an emerging growth company ready DC status.
Through our size and grew volume.
Following trading volume and other assets, but losing that data.
As of year end, where we're adopting at poor in December for the full year I think the good news is and we fully expected that given the short term nature of our loan given that they're fixed rate [noise] where'd you in the process of implementing we have preliminary results from our model.
And we're very confident that the any impact with many of them will be material I think the thing we've been focused on as we implement them implemented its the uniqueness of our portfolio based on more dependent on the fixed rate nature. So we're just trying to implement a solution for since all that is why did the bowl and compliant and not.
Okay.
Well for the company something that we can we maintain them. We're almost there we feel good about that.
The key takeaways, we're not expecting any significant impact.
Our current level of reserves.
Great. Thanks for taking my questions I appreciate it.
Thanks.
Thank you.
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, Steven Thanks for your support and.
You all know how to find us if you need us and stay safe to say healthy enjoy your holidays and we'll talk soon.
Thank you 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.