KBRA Newmark Group Inc. Ratings Release

NEW YORK--(BUSINESS WIRE)-- Earlier this week, Kroll Bond Rating Agency (KBRA) assigned an issuer rating of BBB- with a Stable Outlook to Newmark Group Inc (“Newmark”). The issuer rating assumed that Newmark will retire existing short-term borrowings using proceeds from a proposed senior unsecured note offering, to which KBRA also assigned a BBB- rating and Stable Outlook.

Newmark is a $3.0 billion (total market cap) diversified real estate services company providing a wide range of commercial real estate services—including investment sales, leasing, commercial mortgage loan origination and servicing, building and facility management, advisory and valuation—to tenants, owners, and investors. Newmark has grown rapidly since its 2011 acquisition by its current parent BGC Partners (“BGC”), acquiring nearly 50 companies. Newmark ranks among the top five investment sale brokers, is a top five Fannie Mae and Freddie Mac lender, and ranks among the top ten companies in mortgage brokerage. Newmark has offices in 90 cities and over 5,000 employees, and projects that 2018 revenues will total approximately $2.0 billion.

The rating and outlook reflect favorably on Newmark’s low current and targeted maximum leverage, scalable and diverse operating platform across US markets and property types, history of strong revenue and EBITDA growth, absence of near-term debt maturities following the note offering, and considerable retained cash flow relative to moderate ongoing and manageable acquisition-related capex funding needs, the latter enhanced by Newmark’s partial use of equity to fund acquisitions and compensation.

Credit strengths are balanced by exposure to recession-sensitive transaction-based investment sale fees and to a lesser extent leasing commissions and mortgage brokerage fees, a high operating expense ratio that is significantly mitigated by the company’s capacity to moderate compensation expenses or fund with equity, the lesser liquidity of its assets relative to property-owning real estate companies (other than future rights to receive Nasdaq shares), potential use of the company’s recently expanded share repurchase program, and external control of the company through a Class A/B equity structure.

KBRA anticipates that proceeds from the proposed Newmark senior unsecured note offering will be sufficient to repay the entirety of Newmark’s existing debt—totaling $547 million owed to or guaranteed by BGC—excluding balances on warehouse facilities associated with origination and sale of GSE multifamily loans, which KBRA deconsolidates for purposes of deriving Newmark’s total debt and credit metrics as discussed further below. Proceeds from the proposed note offering are expected to be distributed to subsidiary Newmark Opco subject to an upstream guarantee. KBRA’s rating anticipates that the proposed unsecured note offering will have no financial covenants.

During 4Q’18 BGC plans to spin off its 59% equity interest in Newmark to BGC shareholders, following which 61% of Newmark’s equity interests would be owned by public shareholders, 21% by Newmark employees, and 18% by Cantor Fitzgerald. Cantor would retain 52% voting control of Newmark and continue to provide the company with administrative, accounting, and treasury support under an existing services agreement.

Newmark’s current net debt leverage represents a low 16.2% of total market cap, 1.24x KBRA-adjusted trailing twelve-month EBITDA of $388 million, and 1.07x KBRA-adjusted projected 2018 EBITDA of $449 million—the latter approximately 15% lower than Newmark’s $528 million 2018 EBITDA guidance (midpoint). KBRA-adjusted trailing twelve-month EBITDA to proforma interest coverage is 12.8x. Newmark has demonstrated strong commitment to deleveraging over the past year, reducing debt by $841 million from pre-IPO levels, with sources including $304 million from its December 2017 IPO, $242 million from its March 2018 sale of partnership units to BGC, $266 million from the forward sale of Nasdaq shares to be awarded 2019-2022, and cash balances.

Newmark has expressed its intention to operate with a maximum 1.5x net debt to company-adjusted EBITDA—which translates into 2.0x net debt to KBRA-adjusted EBITDA, a level that represents the upper limit for leverage at KBRA’s current rating and Stable Outlook. KBRA’s adjustments to EBITDA are comparable to those of Newmark regarding mortgage servicing rights (“MSRs”), deduction of interest associated with GSE warehouse financing, and add-back of “grants of exchangeability” attributable to price appreciation of partnership units that become convertible into shares. KBRA’s EBITDA adjustments differ from Newmark with respect to share-based compensation, which KBRA recognizes as an expense even if non-cash, and KBRA’s normalization of earnings associated with the 992,247 shares of Nasdaq that Newmark will receive in the third quarter of each year through 2027. Newmark’s adjusted 3Q’18 EBITDA recognizes $85 million of GAAP income associated with the eventually non-recurring Nasdaq share award, whereas KBRA recognizes a lower $36 million annuity-equivalent for the remaining non-monetized Nasdaq share awards.

KBRA’s recognition of Newmark debt excludes balances under GSE warehouse facilities that have a combined balance of $1.1 billion as of September 31, 2018. Warehouse obligations are secured by loans for which Newmark has entered into forward purchase and sale agreements (“PSA”) with GSE lenders, pursuant to which the warehouse lenders have historically advanced 100% of underlying loan principal. Risk of delay in closings, which typically occurs within 45 days of loan funding, is limited to property casualty for which the underlying assets are insured (Newmark additionally insured by its own loss policy) or potential violation of representations and warrantees. Were Newmark to begin originating loans without the benefit of executed GSE PSA’s, KBRA would recognize the related assets and liabilities in its leverage metrics.

Following origination of the GSE loans, Newmark retains both the MSRs as well as “risk sharing”, on loans sold to Fannie Mae, for losses up to 33% of loan principal. The fair value of Newmark MSRs was $445 million as of September 30, 2018, with an eight-year average remaining life. While Newmark’s contingent risk-sharing liability totals a considerable $5.3 billion ($19.4 billion in underlying loans), risk exposure is better expressed in the context of loss rates historically incurred by subsidiary Berkeley Point, the guarantor under both the warehouse facilities and GSE risk-sharing, and a seller of loans to the GSEs for more than 30 years. Historical losses over the past 20 years have been minimal. Applying Berkeley Point’s peak annual loss rate during the Great Recession against its current risk share would imply approximately $40 million in losses, as compared to Newmark’s projected 2018 servicing fee revenues of more than $100 million. Historically, Berkeley Point losses have never exceeded the subsidiary’s net income. KBRA views the excess of projected MSR earnings to risk-share losses as incrementally credit positive for Newmark, in consideration of the relative resilience of GSE lending during the Great Recession, and the minimal capital required to fund or grow the business.

Newmark’s overall revenue growth has significantly exceeded peers in recent years, with its projected total 2018 revenues representing a 67% increase from 2015. Between 2015 and 2017, the volume of investment sales and non-GSE mortgage originations in which Newmark earned fees increased by 82% and 178%, respectively. Revenue contributions across Newmark business segments are generally comparable to those of Newmark’s largest peer CBRE that reported $5.4 billion in 2017 revenue from the Americas, although geographically CBRE is considerably more diverse with 42% of revenues derived from other regions. Newmark has derived 40% of year-to-date 2018 revenues (excluding originated MSR revenues) from leasing commissions (38% for CBRE Americas), 24% from investment sales and mortgage brokerage (28% CBRE), 23% from management services and appraisal (30% CBRE), 9% from servicing fees, and 4% from other loan-originated related fees.

The predominant credit risk for Newmark is a downturn in commercial property values and rents, and the volumes of transaction, mortgage, and leasing activity to which its revenues are closely aligned. As a point of reference for potential declines, annual peak-to-trough declines during the Great Recession represented 31% for total revenue of peer CBRE; 35-40% for various commercial property price indices across US property types and markets; an average of nearly 10% for office, industrial, and retail rents across major US markets (source CoStar); 88% for commercial property transaction volumes (source RCA, by 2013 recovered to 37% below peak), and 83% for commercial mortgage originations (source MBA, by 2013 recovered to 30% below peak).

Newmark’s KBRA-adjusted EBITDA margin of 22% ranks among the highest in its peer group. Compensation related expenses (excluding grants of exchangeability) represented approximately 75% of trailing twelve-month operating expenses. Revenue stress tests performed by KBRA indicate that, were Newmark unable to proportionately scale back compensation expenses with a decline in revenues, impact on adjusted EBITDA could be significantly magnified, mitigated by the potential for high degree of expense variability and the company’s discretion over headcount and compensation levels, and ability to preserve cash flow by shifting compensation towards equity awards.

Newmark’s ongoing capex requirements are relatively moderate, averaging approximately $20 million over the past three years. KBRA estimates that Newmark’s 2018 cash flow (after interest and taxes) available for investment or distributions to share/unit holders will total approximately $325 million. After distributions, remaining cash flow would be considerably greater than Newmark’s recent pace of acquisition activity, which has historically been funded with approximately ¼ equity. The company’s use of equity awards to fund incentive compensation and signing bonuses, with equity typically representing 35% of such awards, further enhances capacity for cash flow retention.

The rating considers liquidity of Newmark assets to be limited when compared to property-owning companies and REIT unsecured borrowers that are covenanted to maintain unencumbered asset pools. For Newmark, assets that could be readily monetized are limited to cash and the future value of non-monetized 2023-2027 Nasdaq awards, which represent $426 million based on Nasdaq’s current share price and a KBRA-estimated present value of $193 million. Potential opportunities for monetization of MSRs are complicated by the GSE requirement that MSRs be assigned together with contingent liabilities for risk sharing, Fannie Mae requirements for minimum DUS lender net worth, and the company’s stated plan to eventually sell GSE special servicing rights to Cantor. Should Newmark pursue, prior to maturity of the proposed senior notes, monetization of the remaining 2023-2027 Nasdaq share awards, Newmark’s capacity for bond refinancing could depend primarily or exclusively on earnings growth or available cash.

Drivers of rating upgrade or Positive Outlook: Sustained EBITDA growth; demonstrated ability to maintain net debt to KBRA-adjusted EBITDA below 1.5x; increased diversification of revenue across business segments and proportionately higher fees from more recession-resilient property and facilities management; bank commitments to an unsecured revolving credit facility; and/or surrender of the super-voting rights of its Class B shares.

Drivers of rating downgrade or Negative Outlook: An increase in net debt to KBRA-adjusted EBITDA above 2.0x; deterioration in revenues or operating margins; broad-based deterioration in commercial real estate fundamentals and transaction volumes; anticipation that losses associate with GSE risk-sharing could exceed peak historical levels; expanded share repurchase authorization from the current (but unused) $200 million; liquidity and/or leverage pressure associated with acceleration in acquisition activity or shift in related funding from equity to cash; and/or shift away from equity-based compensation.

The ratings were assigned using KBRA’s Global Equity REIT and REOC Rating Methodology, published November 28, 2017, available at www.kbra.com.

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About KBRA and KBRA Europe

KBRA is a full service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus, is recognized by the National Association of Insurance Commissioners as a Credit Rating Provider, and is a certified Credit Rating Agency (CRA) by the European Securities and Markets Authority (ESMA). Kroll Bond Rating Agency Europe Limited is registered with ESMA as a CRA.

View source version on businesswire.com: https://www.businesswire.com/news/home/20181101005934/en/

KBRA
Analytical Contacts:
Mark Berry, 646-731-2413
Managing Director
[email protected]
or
Eric Thompson, 646-731-2355
Senior Managing Director
[email protected]

Source: Kroll Bond Rating Agency

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