Pleasantly Surprised by Q3 Results

Highlights

Q3 was in line with our expectations. BCF reported record revenue (up 28% YoY) amid higher mortgages outstanding, and lending rates. EPS  was up 17% YoY. 

Mortgages outstanding (net) were up 1% QoQ to $36M – the highest in BCF’s history. 

We believe the risk profile of BCF's portfolio remains stable, with no notable changes in first mortgages, property types, or geographical diversification.

BCF also experienced no material increase in stage three (impaired) mortgages. We were pleasantly surprised, given that most comparables reported a rise in stage three mortgages in the last quarter. Note that property developers, and landlords, have been facing challenges stemming from high borrowing costs, low pre-sales, and dampened real estate activity.

As a conservative response to the deceleration in the sector, BCF raised its loan loss allowances (total reserves assigned for potential loan losses) by 30 bp to 1.58% of mortgage receivables.

We anticipate the Bank of Canada will initiate rate cuts within the next six months, driven by rising unemployment, financial instability, mortgage costs, and consumer confidence, and cooling inflation. Earlier this month, major Canadian banks slashed their mortgages rates by 20 bp on average. We anticipate transaction volumes will pick up in 2024, driven by lower interest rates.

Anticipating a decline in rates, we project higher demand for high-yield stocks, such as BCF. We believe the current price level presents a narrow window to lock in a 9.1% yield.

Mortgage advancements were down 16% YoY; repayments were down 27% YoY

Net mortgage receivables were up 0.7% QoQ to 36M - the highest in BCF's history

irst mortgages remained relatively flat

 

No material changes in geographical diversification

 

Remains focused on single-family units (construction)

 

 

The average mortgage size was up 8% QoQ

 

LTV was down 1.7 pp QoQ, implying lower risk profile

 

Raised lending rates

No material changes in stage three mortgages (impaired), or foreclosed assets
However, loan loss allowances were raised by 30 bp as a conservative response to the deceleration in the sector
For conservatism, we are continuing to model a 100% YoY increase in allowances in 2024

In summary, we believe the portfolio’s risk profile remains unchanged

In Q3, revenue and EPS were in line with our estimates

Revenue was up 28% YoY, and EPS was up 17% YoY, due to higher mortgages outstanding, and lending rates

 

Dividends for Class A investors remained unchanged at $0.80/share, implying a yield of 9.1%

 

No material change in debt/capital

FRC’s Projections and Valuation

As Q3 was in line, we are maintaining our forecasts

We note that the MIC should be able to distribute declared dividends ($0.80/share) even if loan loss allowances are raised by 400%

Sector multiples are down 2% since our previous report in August 2023, and 32% below pre-pandemic levels

Our fair value estimate decreased from $10.15 to $10.01/share due to lower sector multiples

We are reiterating our BUY rating, and adjusting our fair value estimate from $10.15 to $10.01/share, implying an expected return of 24% (including dividends) in the next 12 months. Key risks include a softer mortgage origination market, and higher default rates. Anticipating a decline in rates, we project higher demand for high-yield stocks, such as BCF. 

Risks 

The following, we believe, are the key risks of the company:

 

1. Market concentration: BCF’s primary market is residential construction

2. Allows borrowers to defer interest payments till maturity

3. Credit and collateral 

4. Timely deployment of capital is critical

5. Distributions are not guaranteed

6. Investments in mortgages are typically affected by macroeconomic conditions, and local real estate markets

7. The company uses leverage, increasing the fund’s exposure to negative events

8. Default rates can rise during recession