BRMK - Broadmark Realty: Losing The Fight To Defend Its Dividend As Housing Melts

Summary

• Broadmark Realty moved down by over 13% on the back of a fiscal 2022 third quarter that saw a miss on both revenue and earnings.
• The CFO and CEO have both departed the company in the space of one month.
• Bulls who hoped for the monthly cash dividend, now at 17%, to be covered were disappointed as Broadmark moves to defend its shares.

Seattle-based Broadmark Realty ( BRMK ) has in the space of one month lost its CFO and CEO and published fiscal 2022 third quarter earnings that sent its common shares down double digits. The company recorded misses on both revenue and earnings as Jeffrey Pyatt, the former CEO is expected to come on as interim CEO. His leadership tenure begins in the face of a rapidly deteriorating macro environment and what looks set to be the worst housing market conditions since the 2008 financial crisis. The hard money lender is fully exposed to this with a portfolio of loans to a range of property types from multi-family to commercial.

So why did the stock drop by so much? The internally managed real estate finance company brought in revenue of $27.1 million which was down 11.4% from the year-ago quarter and was a miss of $1.42 million on consensus estimates. The company executed 18 loan originations during the quarter with an average loan size of $7.8 million and an unlevered yield of 12.9%.

However, with total loan originations at $138 million, this meant the fourth straight quarter of falling originations as demand for real estate loans gets disrupted by consecutive Fed interest rate hikes. High inflation has turned the Fed hawkish with the current Fed funds rate now at 3.75% to 4%. This is set to be hiked by at least another 50 basis points at the December Federal Open Market Committee meeting.

This would further increase financing costs and apply more pressure on a national housing market already collapsing. However, the company has historically been very conservatively run with its debt-to-equity ratio standing at 8.8% as at the end of the quarter.

Further, Broadmark's loans remain short-term with a weighted average term of 14 months at origination. The short-duration loans reduce the company's exposure to interest rate movements and allow for a more agile and dynamic approach to lending in their core markets as the environment changes over the next year.

Default Rises As The Economy Faces Headwinds

Net provision for credit losses surged during the quarter to $12.3 million, up from $2.7 million in the prior quarter and $2.6 million in the year-ago quarter. The company's contractual default rate grew to 19% of the total portfolio by value.

This was a new record and came on the back of a national housing market that is in an early stage of collapse. Freddie Mac's primary mortgage market survey has placed the 30-year fixed mortgage rate at 6.95%, significantly up from a year ago when rates hovered just above 3%. Fannie Mae's Home Purchase Sentiment Index has also dropped to its lowest level since 2011 when it reached 56.7 in October , its eighth consecutive month-on-month decline. Critically, and more broadly, as mortgages become more unaffordable for millions, real estate transactions will slow down markedly and push the market into an acute state of shock and stasis.

The median sales price of existing homes is dropping, down 7% from a recent peak of $413,800 to $384,800. The near-term outlook for the US economy is also poor with a recession expected in 2023. But interest rates are expected to peak in early 2023 and inflation to fall closer to the Fed target in the second half of the year.

The toxic and somewhat rare combination of negative economic growth, high inflation, and rising interest rates would further accelerate the trend of collapsing housing sentiment and give further legs to the pullback in house prices and could increase Broadmark's contractual default rate.

The company foreclosed on a small loan during the quarter and received payoffs on six loans in contractual default status totalling $18 million. Broadmark now owns 11 foreclosed properties with $93.5 million in carrying value.

The Dividend Is At Risk

Broadmark last reported a $0.07 per share monthly dividend that was in line with its previous payout. The company is also set to launch a stock repurchase program of up to $75 million. However, the dividend is not covered with distributable earnings prior to realized loss on investments at $18.0 million, or $0.14 per diluted common share for the quarter. This was on the back of a balance sheet with cash and equivalents of $61.1 million and an undrawn $135 million revolving credit facility.

The commons are currently trading at a 33% discount to Broadmark's $7.28 tangible book value per share. Management stated during their earnings call that the near-term focus will be on resolving nonperforming loans as growth and earnings will continue to lag until this is done. Hence, the double-digit pullback makes sense against a deteriorating economy, a dividend not covered, rising non-performing loans, and executive turnover. The stock repurchase is welcome but Broadmark will need to cut its dividend to a healthier level. I'd suggest $0.04 per share for a strong 10% yield. This would allow the company to enter the new year with a more sustainable base as housing melts.

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