Broadmark Realty Capital Inc.

Good afternoon. Thank you for joining us today for Broadmark Realty Capital's Second Quarter 2020 Earnings Conference Call.

In addition to the press release distributed this afternoon, we have filed the supplemental package with additional detail 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 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.

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

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 second 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 how Broadmark performed in the second quarter and provide an update on how we are operating through the challenges posed by COVID-19. I'll then discuss why we believe we are well positioned for longer-term growth, as we emerge from this crisis, given the strength of our balance sheet and secular tailwinds that should help drive our business.

Then I'll turn the call over to David to provide additional detail on our financial results and performance, loan portfolio and balance sheet. When David is finished, we'll open up the call for your questions.

Starting with our originations. For the second quarter, we originated approximately $50 million of new loans, bringing year-to-date originations to $157 million.

We also completed $47 million of loan amendments during the quarter, generating additional fee income while derisking our loan portfolio by a transformation of investment in land to vertical construction. As we discussed on our last call, early in the quarter, state restrictions, permitting and inspection office closures and economic uncertainty all contributed to slower construction activity in most of our markets.

At the time, we were disciplined in our capital deployment, given the uncertainty amid the early stages of the pandemic and originations were modest in April and May. We emphasize that this lower origination volume was not due to lack of demand.

In fact, we received many inbound inquiries from developers whose financing partners had pulled back after losing their lines of credit. We made the decision to deliberately slow our originations in the early days of the COVID crisis until we had better visibility.

As we move through the quarter, we slowly built our pace of originations while maintaining our stringent underwriting standards. So while some levered construction lenders were forced to cut off originations entirely, due to lack of cash, we were able to proceed in a measured manner.

This is working to our benefit. We were able to resume a pace of originations closer to historical level, with 90% of our second quarter originations occurring during June.

All originations can vary month-to-month based on closing times. We regard the pace of June originations is more representative of our historical cadence.

Please see Slide 5 of our supplemental earnings presentation, which provides additional detail on new loan origination of the last several quarters, most of which were disrupted by the merger in the second half of 2019, then COVID in 2020, respectively. However, while we have experienced the near-term COVID related pressures, underlying demographic trends and consumer preferences are likely to provide a strong backdrop for Broadmark as we move forward.

We operate in markets where a strong population continues to stimulate demand for housing. While COVID-19 has affected construction activity with respect to timing, it has not eliminated the significant housing shortage that persist in the states in which we operate.

Also, the combination of historically low interest rate and the growing desire by many for more space amid social distancing and work from home policies, has resulted in explosive demand for single-family housing across the country. We continue to see developers work to respond to that unmet need.

At the same time, we believe that COVID-19 has served to further limit, at least for the near term, the universe of lenders able to finance construction loans, leaving Broadmark with more demand and less competition. Now turning to contractual default.

I remind everyone of our historical contractual default level, which has averaged less than 3% over our 10-year history. With the impact of COVID, contractual defaults have increased over the past 2 quarters, as permitting and inspection offices closed or went remote.

And in some states, halted construction altogether, resulting in construction time lines being pushed out. As a result, some of our borrowers who we believe would not otherwise have faced trouble but COVID, experienced completion or refinancing delays resulting in contractual default.

It is very important to make clear that contractual defaults for Broadmark have historically been part of the process by which we protect our claims against collateral, are normally resolved with minimal, if any, principal losses and have had limited negative financial impact on Broadmark over time. Indeed, in some cases, contractual defaults increased total return as a result of our earning default interest and other fees.

At June 30, we had 30 loans in contractual default, representing 16% of our total portfolio value. The majority of these loans entered into contractual default status in March and April, as we proactively began to work with our borrowers and to exercise our lenders' rights.

March represented the high watermark for new contractual defaults. And since then, new incidents have been steadily trending downward each month.

June and July represented a return to pre-COVID levels of new contractual defaults. We spent some time on our last earnings call discussing what contractual defaults mean for Broadmark, and it's worth reiterating because a contractual default does not necessarily mean a lot.

Over our 10-year history, we have had loans go into and out of contractual default, and the most common result has been a positive economic outcome for Broadmark. Note that our estimated losses on current contractual default is approximately $6.8 million, approximately, 3% of the principal outstanding on the loans in contractual default status and less than 1% of our total portfolio value.

And for most loans that experienced a contractual default, we resolve the issue and collect all contractual interest and fees. In the second quarter, we resolved 4 loans in contractual default with minimal losses previously captured in our reserves and these resolutions provided $14 million in liquidity.

David will provide further detail on these loans later on in the call. We did not foreclose on any properties in the second quarter.

And as of June 30, we have only 1 owned property, or REO, in our portfolio. We believe foreclosure will continue to be a rare outcome of contractual default.

In the past 3 years, we've experienced 75 incidents of contractual default and only 8% resulted in foreclosure. As we work with our borrowers, we have a toolbox of options to help us resolve issues in a satisfactory and often an economically positive basis.

These options include: deferring payments and setting up a plan to bring the loan back to current over time; helping the borrower refinance; putting a receiver in place; working with the borrower to find options to sell the project in an incomplete state that would help them satisfy their obligation to us; or getting a deed in lieu of foreclosure. Remember also that our loans tend to be relatively small and that our borrowers are required to provide significant personal equity, creating a large incentive for them to work with us to cure any issues.

As of June 30, we have executed forbearance agreements on 10 loans with a total value of $41.4 million and 61% of our other nonperforming loans are in an active forbearance process. We believe that by working with our borrowers to resolve contractual defaults, we'll be able to capture our principal, interest and penalties, just over a longer time horizon.

Most importantly, with our significant cash position and with payoffs trending positively, we will have ample liquidity to continue to fund new loans, even as we work through these contractual defaults. Lastly, if we do need to take over a project and finish it, we have the resources to execute on that.

Over the years, we've built relationships with numerous contractors and our strong liquidity means that we will not be forced to sell access quickly at fire sale prices. Furthermore, our maximum 65% loan-to-value ratio means that we have a meaningful value buffer in the event that we need to foreclose and sell a project.

To summarize, COVID-19 did lead to a slowdown in our originations and an uptick in our contractual default rate. However, as we progress through June and July, we've seen encouraging signs of a reversal in those trends.

We resumed originations at a more normal cadence and new monthly contractual defaults have returned to pre-COVID levels. As we sit here today, our borrowers are seeing fewer construction financing options even as demand for single-family housing is rising, increasing the need for more construction.

Our pipeline is strong. And we are confident that we are well positioned over the long-term to continue to grow our loan book.

Of course, these improvements depend on the path of the COVID-19 situation. Construction activity has resumed in all of our markets, but the recent increase in case counts across many states has raised the possibility of further restriction.

Given the significant uncertainties, our Board of Directors aligned our dividend with our second quarter core earnings of $0.18 per share. For the month of August, our Board declared a dividend of $0.06 per share.

Of course, our intent is to grow our earnings and therefore our dividend over time, and our Board will continue to evaluate and set an appropriate dividend rate on a monthly basis. As of the close of business on August 6, we currently have approximately 7.4% yield in a world where treasury rates are near 0.

Finally, let me give a brief update on an important area of focus for us. Our environmental, social and governance or ESG initiatives.

Our mission is to empower real estate developers and investors to improve places to spaces in our communities. To that end, we adhere to 6 core values: integrity; collaboration; diversity; accountability; community; and reliability.

One way in which we strive to become a more socially responsible company is by matching our employees' charitable contributions. This has been especially rewarding in recent months as our team members have been focused on helping their favorite organizations during this difficult time.

Furthermore, we feel it is incumbent on us as business leaders in our communities to engage with difficult social issues rather than shying away from them. I recently signed the CEO Action pledge for Diversity and Inclusion, joining thousands of CEOs in committing ourselves to creating more inclusive workplaces.

And our COO, Linda Koa, has signed the NAACP Pledge to Stop Hate. We also joined the Stop Hate for Profit campaign, suspending our Facebook advertising in July as part of a movement against intolerance online.

And from a governance perspective, the management team at Broadmark is uniquely aligned with investors as we are internally managed and management has significant stock holdings. I'll now turn it over to David, who will review our financial results in more detail.

Thanks, Jeff, and good afternoon, everyone. Let me start with the fact that we earned $20 million of net income in a quarter where our new loan originations were primarily limited to 1 month by the uncertainty of the pandemic and our commitment to taking even more discerning approach to lending.

As for the details of our operating results, which are detailed on Slide 4 of our earnings. For the second quarter of 2020, we reported total revenue of $29.1 million and net income of $19.8 million.

On a per share basis, this reflects a GAAP net income of approximately $0.15 per diluted common share. Adjusting for the impact of nonrecurring costs and other noncash items, our core earnings for the second quarter were $23.4 million or $0.18 per diluted common share, matching our dividend rate for the quarter.

Interest income on our loans in the second quarter was $22.2 million and fee income was $6.9 million. With regard to origination volumes, which are presented on Page 5 of the earnings presentation, in the second quarter, we originated 16 loans with a total face value of $50 million.

As Jeff mentioned, the vast majority of our second quarter originations, $45 million worth, took place in June, as we slowed originations in April and may during the height of the COVID lockdown measures. Given the unprecedented events this quarter, we also want to provide an update on July activity, which included $88 million in new originations and $15 million in amendments, including conversions from land to vertical loans, exceeding our June numbers.

We view the July and early August positive pace of originations building toward pre-COVID levels, subject to further COVID disruption, to be positioning the company for growth as we move ahead. As we have previously mentioned, 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 industry-leading balance sheet. I would like to give a brief accounting update as it relates to our contractual defaults beyond the comments Jeff provided.

Every loan in contractual default status has been evaluated for potential losses, and we have recorded aggregate estimated losses on these loans of $6.8 million as of June 30. This is down from the $7.2 million of estimated losses as of March 31 and represents 3% of the principal outstanding on loans currently in contractual default and less than 1% of our total loan portfolio.

As we have said in the past, the contractual default is a means to protect our interest in collateral. And in most instances, contractual defaults are resolved without issue.

Even in these uncertain times, our strong underwriting model and ability to manage through contractual defaults demonstrates that we continue to operate effectively. Also, the contractual default does not mean we earned no income.

To date, we have recognized more than $35 million in revenue from fees and interest on loans currently in contractual default status, and we generally expect positive economic outcomes upon exit. In addition, as detailed on Slide 11 in the earnings presentation, we have 0 debt and $218 million of cash on our balance sheet as of June 30, 2020.

We believe our liquidity positions us well as we work through our current pipeline. Also, as we have previously mentioned, we intend to put a modestly sized working capital credit facility in place to free up a significant amount of existing cash on our balance sheet for deployment into new loan originations.

We expect to finalize this credit facility by year-end. Our private REIT, which launched in March, participated in 16 loans in the second quarter for a total participation of $6 million as of June 30, 2020.

As we expected, the heightened market uncertainty resulting from COVID-19 has contributed to slower fundraising, but we expect the pace to slowly improve as long as markets continue to stabilize as we have seen in recent weeks. We believe that implementing a working capital credit facility and our strong pipeline of accretive loans will lead to positive growth of our earnings and dividend in the near term.

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

Thanks, David. To recap, as we navigate the COVID-19 crisis, we feel confident that our fortress balance sheet, experience and expertise will allow us to continue to ramp up our originations and grow Broadmark as a lender of choice for developers.

While COVID-19 presents some near-term uncertainty, we believe the demand for housing remains strong, supporting demand for our loans and our reputation as a reliable lender, offering speed and certainty of execution, will help us continue to grow our pipeline. This completes our prepared remarks.

We will now open up the line for questions. Operator?

So first off, I hope everybody's well safe and healthy, good to hear from you. Talk -- looking at the new originations, great to see that turn back on there or I guess late May and then in the majority in June.

Can you talk about the underwriting standards? How you're thinking about new originations post-COVID versus pre-COVID?

The LTV doesn't look to have changed materially, but can you talk to maybe other characteristics that you've lasered down on or changed in any way?

So I'm always reluctant to say that we change our underwriting with various things in the market. We like the way we have it set up.

We certainly never go over our 65% loan-to-value. Where you might see something change, if you were to look loan by loan, comparing today with, say, 6 or 9 months ago, it's quite possible that the loan term will be a little longer.

It will have a little more interest reserve in there. We've always looked at what we expect the value to be at completion and not just what it is today.

So extrapolating in a post-COVID era is probably different. But I think mostly, we just try to stay real tight with our underwriting.

And as I said, we might build a little extra term in just knowing that things are going a little more slowly than usual.

Great. And hard to read a lot into slight changes in mix.

But looks like Texas and Southeast exposure are up a little bit at the expense of Washington and Utah. Also looks like CRE up a little bit at the expense of for rent and land.

Anything behind those slight shifts? I know that geographic diversification has been a focus and that will gradually take place over time.

But any other -- anything else going on with the shift in mix either by geography or property type or loan type?

By geography, certainly not. We continue to push on all 4 regions.

I think percentage wise, the best odds are in the Southeast and mid-Atlantic region because they're smaller to start. But the Mountain West, Texas, if that might go up because we do a big loan, Washington might go down because we have a payoff and then that might flip a month from now.

As far as product type goes, we are -- we still like single family and multifamily housing and we're really trying to push there. We have brought our land exposure down as we had expected we would.

We've had loans that we had classified as land convert to vertical construction. We like that.

As you may know, I think we've said it before, we look at land loans really as providing lot inventory for our homebuilders or apartment builders. And so -- and they need a lot of inventory.

And so we don't want to just be land developers, but we like to provide them with the products so they can continue to build houses.

Great. And my last question, David, shift over to you.

G&A, I know there were some onetime items in there. Can you maybe break that down a little bit more for us?

So the $4.5 million for the quarter or, I guess, to cut to the chase, what should we really think about as a run rate go-forward number for G&A expenses?

Yes. I would say -- thanks for the question, Stephen.

And G&A, any time for a first year public company, it's a little bit hard to project, obviously. We're definitely incurring a little bit more legal costs with recurring costs related to SOX implementation.

I kind of expected to see a little bit more in Q1 and Q2 as we really are focused in on the implementation of SOX. We expect some of those to normalize.

But I think if you look at our core earnings in terms of what we're backing out from first year public company transition expenses, it gives you a little bit more of a normalized run rate for probably future years. But I think between the 2 periods, we're probably looking at something between $4.5 million to $5 million a quarter for cash expenses.

I would say the other thing to note, on Q1, we had reverse in general entry related to some amortization, which threw off the G&A a little bit. So it looks -- it was actually a decrease to expenses.

So it made Q1 look a little bit lower versus Q2. But generally, again, this year, we're going to have a little bit more legal and accounting and professional fee costs just associated with being a newly public company, but we think we've gotten a good grasp of them.

And we expect them to start going down over time as we continue to internalize all those functions.

Great. And I guess as a slight follow-up to that.

Will there be any onetime expenses associated with the credit facility that you guys intend to get in the second half? Or is that just going to be amortized into the...

It will generally be capitalized and amortized if we would like.

Just on the 2Q and 3Q originations so far, have the yields on those loans been consistent with historical average? Or just wondering if you're able to pick up a little bit of yield, given the -- just the economic environment or vice versa, if you've seen those come in a bit?

David, do you want to take that one?

Yes. Yes, absolutely.

Thanks for the question, Tim. No, we haven't changed.

Our products are exactly the same. We haven't had a need to change our rates.

We're not looking to increase rates and take advantage of the market. I think more importantly, what we're seeing is better opportunities, maybe some better borrowers and different collateral that maybe didn't come to us in the past because some of our competitors have been struggling.

So I think we're allowed to be more picky than usual. I mean, we always have our same underwriting standards.

We're applying them probably more stringently. But I think the change over the last 2 quarters is I think we're seeing deals now that maybe didn't come to us and went somewhere cheaper in the past.

So I think that's probably the biggest thing. But to answer your question directly, no, we're still doing the same 12% -- 10% to 12% interest rate and 4% to 5% origination fees.

So no change there.

And Tim, if I can add just a bit of color.

Sure.

I'm thinking of one competitor in particular that when they had -- when they were trying to get deals on their books, if they had a little extra money, they would just undercut their pricing and slash it. And then the same borrower would come back to them another time when they were low on money, and they would be priced at 30% or 50% higher than the last deal.

And as you know, roughly 2/3 of our business is repeat business. And part of that is because our borrowers know exactly what they're going to get every time they pick up the phone.

And so this doesn't feel like the time to try to take advantage of them and boost our yield.

Makes sense. Well, glad to hear that hold up and no major changes there.

And then I know you gave some good -- some color on July so far. Just wondering if we would be able to get a few other data points.

Would you be able to disclose how repayments looked in July so far? And then if there's any update on the private REIT AUM in the third quarter you can give so far or if it's pretty static at about $12.5 million?

Yes. On the payoffs, we haven't publicly disclosed the activity for July, but I can say it's more normalized.

I mean, just to put something to perspective, right, Q1, we had a total payoff of about $126 million; Q2, that decreased to $75 million. Somewhere probably in between the 2 of those is a normal run rate, but definitely closer to Q1.

Q1 was a little bit high. Q2 was overly low.

So typically, historically, we've seen something around $30 million a month of payoff would be even as you will know for us. So that's kind of what we're expecting to continue to see in the upcoming quarters.

And then on the private REIT, no material changes. We'll continue to -- and in the near term kind of release our press release or 8-K showing that the assets under management, no huge activity in Q2 or in the months since Q2.

But it's something that we continue to really hammer. We're really looking to grow the private REIT.

We've got a sales team that is working terribly hard in a very difficult environment to raise capital. So I think it's something that we're continuing to monitor, continuing to work really hard, and we expect, ultimately, we'll start getting closer to the target levels that we originally had.

Got it. Okay.

And then I know you mentioned that contractual defaults have come down in July so far. Would you be able to just give us that data point on kind of where it stands right now?

And then maybe a little bit of color on if the drop there is because you put more loans into forbearance? Or if you just extended these loans and they're not technically in forbearance and you're able to clip your fees as you normally do?

Or just any other tidbits you can throw out there would be helpful.

Sure. Yes.

It's not public. We didn't publicly disclose too much.

We had -- so I can say that we had 0 default -- new defaults in July, which is positive. I think we had 1 or 2 new defaults in June.

So I mean, we're really focused on the new defaults. The reality is the existing defaults, we had a really big uptick in Q1.

I think we had 22 of our defaults were new in the 3 months ended 3/31. Since then, I think, 5 have paid off, 10 have entered forbearance agreements.

And then we got another 8 or 9 new defaults in Q2. So the positive trending is that we're -- we've basically halted new defaults, which is great news.

The [indiscernible] defaults that really kind of came to fruition at the end of Q1 when COVID really started to hit home. We're working those really hard.

They're not going to get resolved overnight, but we're expecting each quarter to work on a chunk, get a chunk resolved, whether that's -- we're hoping more for payoffs and exits of the loans. The forbearance agreements are helpful.

It oftentimes will allow us to get some collections, right? Some of these loans were not paying.

They entered forbearance agreement. All these -- I think it's important to note that these loans that are in default status as of 6/30 and 3/31, frankly, are pretty much all complete projects.

They're not sitting on a bunch of construction in progress. A lot of them are actually now revenue generating.

So the forbearance agreements, what that allows us to do is say, hey, we're not going to go close on you, but any of those rent collection should be paid back to us. So we'll still get some income off those loans.

But ultimately, we want to just exit them off our books and really start to get the full interest income on our portfolio.

I see. Okay.

All right. And then just one more for me.

I think last quarter, you guys mentioned that you were interested in pursuing some portfolio acquisition opportunities. And just wondering if that's still -- forgive me if that was maybe your fourth quarter call.

I don't remember off the top of my head, but just wondering if that's something you're still interested in, if you're seeing any opportunities there from some of your distressed competitors or if that's maybe not as much of a target as it maybe was earlier in the year.

Sure. Yes.

I would say we're always open -- we're always going to pick up the phone and hear about opportunities out there, and we did that. We looked at some portfolios in Q2.

Nothing ultimately worked out. And honestly, we'll continue to have those conversations.

If it makes sense and it's accretive to our shareholders, it's something that is of interest to us. I would say, in the meantime, we're really focused on originating our own loans rather than acquiring someone else's loans.

If there's a deal out there, obviously, we'll look at it. But we've got a healthy pipeline of loans that we can underwrite based on our standards and there's no skeletons in the closet or anything like that.

So that's the primary focus right now. But as I mentioned, we'll always pick up the phone and have those conversations and see if something makes sense.

Got it.

And Tim, if I can go just -- if I can go a little further on that one also to David's point about our own portfolio. We -- and we try -- I try not get into loan level detail, but sometimes I can't help myself.

We had an opportunity come to us in Austin, a really nice loan on a project that was basically -- I think it was well into its construction process when COVID hit and that lender was unable to complete it and this developer needed to keep going, obviously. And so came to us candidly in a panic.

We underwrote it quickly. We were able to close on it.

We got a really nice loan out of that. So that's not buying a whole portfolio, but that's buying -- that is buying a piece of someone else's portfolio as they were going down.

Another example. Similar homebuilder, a build-to-rent homebuilder in the Florida market came to us when they were in a pinch.

They had more traditional financing that was dragging out. And they came to us because they needed to get a small deal closed quickly, and we were able to perform.

They had watched us for most of the year. Finally gave us a chance.

They now are a reference for us and build these homes by the dozen and we're their go-to lender. So we want to take care of our current borrowers and we -- while we may not be looking at whole portfolios, and we certainly will, as David said, we're getting nice little pieces of other portfolios from lenders that either have had to scale way back or maybe are no longer in business.

Got it. Yes.

No, that's a good little anecdote there, Jeff. Appreciate.

It's always good to just get a kind of a visual of how this -- how you can actually benefit in a situation like this. So I'm just going to sneak in one more, if I could.

Just -- you mentioned that your current cash balance represents 84% of unfunded commitments currently. Just can you remind us what your kind of cash target is there?

And how much cash you feel comfortable deploying right now? Because I know 3Q activity has been pretty strong.

And I don't know exactly what repayments are at this point, but I imagine they're lower than what you've originated so far. So just wondering how low that number has come down and how comfortable you are with it at that level.

Sure. Yes, I can comment on that, Tim.

So we're still at over $200 million as of today, a little over $200 million. That percentage has probably come down from 84%, but we're targeting I would say 2 things.

We had extraordinarily high percentage of cash on the balance sheet as of Q1, Q2 that started to come down. I expect it will probably come down a little bit in Q3, but it's something that we continue to monitor and pay high attention to because we always want to have enough cash on our balance sheet to finish projects and make sure that if we have to take over the projects, we can do that.

With that being said, we're looking to be way more efficient with our -- in our cash and that's really the focus of the credit facility that we've mentioned a couple of times. I can't comment what exactly the timing is, but that's something that we foresee taking our levels of cash as a percentage of holdbacks somewhere between 70% and 80% historically down to at least 50% where we're comfortable holding -- still holding well over $100 million of cash on the balance sheet but freeing up just cash sitting there right now for deployment and to deploy that origination pipeline we have.

So there isn't a magic number per se, but we know the number can come down. We're comfortable with it below 84% where it was at Q2.

And ultimately, with the credit facility in place as a cash management tool backed up, the company will bring it significantly lower than 84%.

Before we close, I thank you all for your time and your confidence. I hope you all enjoy the rest of your summer, stay healthy, and we'll see you next quarter.