Broadmark: A Main Street Capital In The Making
- Broadmark has had a difficult public market career.
- That was primarily a timing issue, and we believe the company can still deliver good adjusted returns.
- The recent drop set up a great entry point.
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A long watchlist is instrumental in finding good stocks to buy. A lot of the process is simply waiting until you can pick up a great stock at a great price. That also requires tons of patience and willingness to buy when it appears the sky is falling. We established a new long position recently in Broadmark Realty Capital Inc. (BRMK), and that came after a lot of "watching. We tell you what the company does and why we established a long position.
BRMK is a relatively recent entrant to the capital markets and went public in late 2019 as a REIT.
Privately though, it has been active since about 2010. BRMK is a hard money lender. The company offers short-term loans for modest amounts up to $40 million). These are secured by residential or commercial real estate assets and the projects involve construction or redevelopments.
Hard money lenders focus on the collateral (underlying value of what they can capture) versus a standard credit rating. The process is generally quick as time is of the essence in these projects. It involves figuring out what has been invested and what it will cost to finish the project. The biggest risk, of having to sell the collateral in the market to recover the loan value, or get it finished by someone else and then sell it, is what the company focuses on. This is a very different strategy than what you would see with the conservative regional banks for example. Those tend to boast of extremely low non-accruals and even lower charge-offs. BRMK expects non-accruals to show up. The logic is that this is not a prime borrower coming into BRMK to pay an exorbitant lending fee and interest. Those tend to go to the big banks or the local ones. No, the person coming in typically has little to no credit history but has a buildable project that needs financing.
This is a difficult task to accomplish as it requires a very specialized skill set.
Over its entire public and private history, BRMK has done this reasonably well with a tiny amount (0.3%) of losses.
Outlook & Valuations
The company has struggled to cover its dividend of 84 cents a year (7 cents a month), and this continued even in Q4-2021 with both GAAP and distributable earnings falling short of the 21 cent mark.
Going public right near the onslaught of the pandemic put BRMK in a continued defensive position and it has had to work through an above average number of defaults. This process is not yet over and close to $191 million is currently in default.
This obviously has rumors of a dividend cut swirling. Our opinion is that with so many quarters of uncovered dividend payouts, a cut is obviously possible. What works in favor of dividend preservation is that BRMK issued its inaugural debt and that gives it more capital to earn its dividend. On the flip side, on Q4-2021 conference call, the company guided to reduction in interest rates and fees. This was thanks to increasing competition for the same loans. These two factors offset each other and we are still left with a base uncovered dividend. So why did we consider buying this?
The rationale here is to focus on the company and its longer-term track record rather than penalize it on the risk of a dividend cut. Here the longer term low losses give us comfort that BRMK is a company we want to own. That settles that part, but the key question is of course, "at what price?"
BRMK has all the characteristics to us of Main Street Capital (MAIN) and we think longer term it should command a premium to its NAV/Tangible book value. The two are different on paper. One is a REIT and the other a BDC. But both lend money to the lower rung of credit quality and bet on their ability to figure out where their losses will be minimal. Of course, BRMK has a lot more to prove in its public career, but we think it can do it.
If the company executes as expected, then the pre-pandemic premium to NAV is where we think it will trade. This is in the same range as the respect MAIN as acquired.
Putting it another way, if we got to buy this at NAV/Tangible book value, we would be ecstatic. Based on the Q4-2021 results that works out to close to $7.50 per share. Of course, we did not have insight into the exact numbers when we initiated the trade, but a rough ballpark works for these things. We sold the $7.50 Cash Secured Puts for October 2022 for 55-60 cents as BRMK tanked on February 24.
To us, this is a great price to buy this company, whether or not they cut the dividend. If we don't get to buy it, as in it stays above $7.50 at October options expiration, well, that is a nice annualized yield for putting our bid in and higher than the 10% yield on the stock. The traditional win-win of a defensive buy.
BRMK has the right balance sheet for the business it is in. Till recently, they had zero debt and the recent issuance still gives them great ability to maneuver.
As with all our positions, we maintain strict limits on position size and monitor risk levels. This one has started out small, but if they do land up cutting the dividend, expect us to get aggressive.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of BRMK either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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