2023-03-05 23:36:55 ET
Summary
- Ready Capital is merging with Broadmark Realty in an all-share transaction that will see Broadmark's shareholders receive 0.47233 shares of Ready Capital per Broadmark share.
- The deal will immediately have a deleveraging effect on Ready Capital's balance sheet.
- The buyout by Ready Capital fundamentally represents a salvo as Broadmark's distributable earnings and monthly dividend payouts were in freefall.
Ready Capital ( RC ) is merging with Broadmark Realty ( BRMK ) in an unexpected all-stock deal. The announcement of the buyout was timely, occurring the same morning Broadmark was to release earnings for its fiscal 2022 fourth quarter. Critically, the earnings report was poor with dual misses on both revenue and earnings and the already halved monthly dividend facing a further battle to be maintained.
So what does the acquisition mean for Ready Capital and Broadmark's shareholders? For Broadmark, it essentially amounts to a bailout with the commons likely to have faced material pressure following the fourth-quarter earnings report. The performance of both mREITs over the last 12 months is stark with Ready Capital down 16.4% on a total return basis versus a loss of 30.7% for Broadmark. Both mREITs peaked in the summer of 2021 when inflation was low, the economy was buoyant, and animal spirits were running wild.
The deal will see each of Broadmark's commons converted into 0.47233 shares of Ready Capital. Using the closing price of both securities on March 3, 2023, would imply a price of $5.28 per Broadmark share. Ready Capital pulled back sharply following the announcement as it will see 63 million new shares created.
Ready Capital anticipates completing the merger by the end of its fiscal 2023 second quarter ending in June. Hence, upon completion of the merger, the larger company is expected to have a pro forma equity capital base of $2.8 billion. This equity base would be formed from $1.9 billion from Ready Capital with Broadmark's contribution at $900 million. Essentially, Broadmark's shareholders will own around 36% of the enlarged company with Ready Capital's shareholders owning the remaining 64%.
Saving Broadmark: The Value For Both mREITs
Broadmark last declared a monthly cash dividend of $0.035 per share , in line with its prior payout and for a yield of 9.8% against the immediate pre-merger price of its commons. This almost double-digit yield has been the product of a rapidly collapsing stock price. Broadmark's monthly payout was as high as $0.12 per share at the start of fiscal 2020.
Broadmark like other mREITs was forced by the pandemic to slash its payout and whilst it raised this once at the start of 2021, rising Fed funds rate in response to inflation that remains elevated has exerted immense pressure on its balance sheet and forced this backdown. Broadmark's last reported earnings saw revenue come in at $21.07 million , a decline of 32.7% over the year-ago comp and a miss by $5.55 million on consensus estimates.
The revenue decline was driven by fiscal 2022 fourth quarter loan originations of only $43 million. This was down from $248.6 million in the year-ago period and sequentially from $138 million in the third quarter. The total collapse of originations, below the early pandemic period, is more of a reflection of the Ready Capital merger than an underlying problem with the lending business. Broadmark's originations have been trending lower since the third quarter of 2021 on the back of tightening credit market conditions as rising Fed funds rates and recession fears continue to disrupt the commercial lending market.
Broadmark's total loan portfolio as of the end of the fourth quarter stood at $1.4 billion with an unlevered asset yield of 12.9% and an extremely conservative 0.1x debt-to-equity ratio. This was a fundamental rationale for the merger by Ready Capital as Broadmark's largely unlevered portfolio will have a de-leveraging impact on the enlarged company. Essentially, Broadmark will boost Ready Capital's unrestricted cash by $55 million to $219 million and will cut down recourse debt to equity by a third to 1x from 1.5x. Total debt to equity is also set to drop to 3.4x from 5.1x. The deal will activate $500 million in excess liquidity in the first year post-merger close via Broadmark's cash and equivalents, portfolio run-off, and secured leverage opportunities from the currently unlevered portfolio.
A New mREIT Is Created
The buyout is somewhat beneficial for both companies with Broadmark's common shareholders getting 36% ownership in what will become the fourth largest commercial mREIT. Ready Capital's last declared quarterly cash dividend payout was $0.40 per share . Whilst this was a 4.8% decrease from its prior payout, its management more successfully navigated the pandemic.
The reduced payout is still in line with its pre-pandemic level. Further, Ready Capital's annualized yield at 14.3% is 450 basis points higher than Broadmark's pre-merger yield. Broadmark's tangible book value per share as of the end of its fourth quarter stood at $7.05. Hence, at the current implied buyout price of $5.28, Ready Capital is merging with Broadmark at a 25% discount to tangible book value, or 75 cents on the dollar.
Whilst book value has been declining on the back of rising contractual defaults, the discount to book still represents some value for Ready Capital. Overall, Ready Capital is merging with Broadmark because it perfectly complements its commercial lending business, was trading at a large discount to its intrinsic value and will provide a significant level of incremental liquidity and deleveraging. Ready Capital has proved itself to be an astute and opportunistic acquirer of mildly distressed assets with this being its second merger within 12 months.
The mREIT closed on its merger with Mosaic Real Estate Credit in March last year. There is still some uncertainty around the frequency of the dividend on the enlarged company with a move to a monthly payout schedule not floated by Ready Capital's management. I sold my Broadmark position on the back of the merger announcement but might reconsider a position in Ready Capital in the later part of the second quarter.
For further details see:
Ready Capital Saves Broadmark Realty From Collapse