Trinity Merger Corp. to Combine with Broadmark to Create Listed Mortgage REIT
From Travel-as-a-Service to Space-as-as-Service, the IPO market has been dominated by big promises and little profits in 2019. For those seeking a new listing with a track record of steady returns, there is an appealing choice on the menu.
Meet Broadmark, a real-estate lender that plans to go public through a merger with Trinity Merger Corp. (ticker: TMCX) and become a real-estate investment trust (REIT) upon closing. The latter is a special purpose acquisition company, or SPAC, that raised $345 million in May 2018 to find a target and in August announced the deal with Broadmark. After the merger is complete in the fourth quarter, the new company will be renamed Broadmark Realty Capital Inc. and have a roughly $1.5 billion market capitalization based on the current share price.
Broadmark should attract investors for several reasons. The company, which was founded in 2010, was early to take advantage of a regulatory clampdown that prevented many banks from extending loans to regional builders and developers. That created an opportunity to extend loans to very-high quality borrowers with the backing of underlying property.
The head start that Broadmark got at the beginning of the decade helped cement relationships with borrowers that are unlikely to shake loose. There’s no indication of commercial banks making a run at its customers while regulators remain watchful and loan approvals are arduous. Also, having boots on the ground for so many years has given Broadmark market intelligence that other players simply don’t have.
Indeed, roughly 65% of Broadmark’s business comes from repeat customers. That suggests it’s not simply competing on price but finding borrowers returning because they are happy with the experience.
The result has been nearly a decade of negligible loan losses and steady returns. In turn, the REIT has delivered distributions with yields in the 10% to 11% range. Broadmark plans to maintain a dividend of $1.25 to $1.30 per share, implying a yield around 12% at the current share price.
Importantly, Broadmark has operated without any debt and plans to continue that strategy after the deal. Such a conservative strategy is critical because it removes the risk of losing credit lines in the event of an economic downturn, which could be crippling.
That’s appealing to borrowers who don’t have to worry about Broadmark’s capital disappearing. Indeed, many other mortgage REITs that do use debt could run into serious trouble if they lost credit, leaving Broadmark in a position to win business. So while a downturn could cause defaults to pick up, Broadmark would be poised to pounce on new business when rivals are forced out of the market.
While Broadmark remains debt free, the deal will involve plenty of cash from both the SPAC and a private investment of $75 million from Farallon, a global asset manager. Broadmark expects to have $283 million of cash to direct toward new loans.
Those additional loans can help Broadmark grow its dividend over time. And if needed, Broadmark could issue more shares to fund expansion.
Broadmark can also raise capital in a private REIT. That could benefit public shareholders because the in-house asset manager would collect fees on the new private assets. That internalized structure is also a positive for shareholders because it eliminates external management fees, which can be very costly.
Another reason for optimism is geographic positioning. Broadmark operates in nine states selected because of healthy demographic trends such as population growth and employment. Those states include Washington, Colorado, and Texas, where trends remain strong.
That said, Broadmark can be nimble and isn’t married to any particular city or state. Its typical loans last just three to 18 months, allowing it to shift its focus quickly. And if a borrower does need to extend, Broadmark collects a fee.
Another unusual feature of the deal is the potential investors that come along with Broadmark. Some 1,800 investors have put money into Broadmark REITs privately. Given their positive experience over the last several years, and history of rolling distributions back into the company’s REITs, it stands to reason many of them should want to own Broadmark in the public market.
Current Broadmark unitholders have the option to redeem for cash on or before September 23, 2019. But if they do so, they would miss potential dividend payments scheduled ahead of the special meeting to approve the merger.
At the current share price, Broadmark also has room for capital appreciation, given its expected dividend yield of 12% – well above other internally-managed mortgage REITs. Ladder Capital Corp. yields 9%, Arbor Reality Trust, Inc. yields 9.1%, and Manhattan Bridge Capital, Inc. yields 7.9%, according to Sentieo.
What’s more, a falling interest rate environment should be supportive of high-yielding REITs. Broadmark’s customers are not likely to expect lower rates on loans if the Federal Reserve eases, meaning its dividends should hold steady.
There is also a decent chance that shares of Trinity Merger Corp. begin to rally even before the deal closes, as has happened with other attractive SPACs. There is limited downside, given the current share price is essentially backed by cash in a trust account.
In addition to a proven business model, investors also buying into an experienced management team at Broadmark, including CEO Jeffrey Pyatt, who has been with the company from the beginning and has 30 years of industry experience. With markets near all-time highs and serious uncertainty in many sectors, Broadmark stands out.