Lower Rates Drive Growth Prospects / Posts Record Q2 Revenue

Report Highlights

• Stage three mortgages (impaired) decreased QoQ, from 2.3% to 1.7% of mortgages. However, for conservatism, management raised loan loss allowances by 0.2 pp QoQ to 2.73% of mortgages, aligning with our estimate.
• We believe the portfolio’s risk profile has decreased due to lower stage three mortgages, and enhanced geographical diversification. 
• The company is pursuing a $50M bond financing. We believe this financing is indicative of the company’s robust pipeline of mortgages. Bondholders will participate on a pari passu (equal) basis with shareholders. 
• BCF’s lending rates have started declining following the Bank of Canada’s recent rate cuts.  Today, the BoC lowered its benchmark rate by 25 bp, marking its third consecutive cut since June. With cooling inflation and a softer jobs market, we expect further rate cuts, and a boost in BCF’s transaction volumes in H2-2024. 
• In our May 2024 report, we predicted a rally in MIC/financial stocks driven by lower rates, and sector multiples have since risen by 8%. We remain bullish on MIC and financial stocks, expecting further rallies with additional rate cuts.

Price and Volume (1-year)

Portfolio Details

Mortgage advancements were down 1% YoY; repayments were up 8% YoY. Mortgage receivables (net) remained flat QoQ at $31M; we are lowering our year-end estimate by 2% to $35M 

We will incorporate the impact of the ongoing bond financing on our models upon  completion.  First mortgages decreased, implying higher risk

Increased exposure to AB, and decreased exposure to B.C. as management is observing more attractive opportunities and fewer competitors in AB  

Remains focused on single-family units (construction). The average mortgage size was down 7% QoQ, implying lower risk

LTV was up 2.7 pp QoQ, implying higher risk

The average lending rate declined slightly, primarily due to the BoC’s rate cut in June. Stage three mortgages (impaired) decreased QoQ, from 2.3% to 1.7% of mortgages

However, for conservatism, management raised loan loss allowances by 0.2 pp QoQ to 2.73% of mortgages, aligning with our estimate

In summary, we believe the portfolio’s risk profile has decreased (two red vs three green signals)

Revenue was up 3% YoY, beating our estimate by 5%, due to lower than expected mortgage receivables. However, EPS was flat YoY due to higher loan loss provisions, missing our estimate by 4%

Net income increased 1.23 pp to 10.58% of mortgage receivables, due to higher lending rates. Dividends for Class A investors remained unchanged at $0.80/share, implying a yield of 8.9%

Debt/capital remained flat 

FRC’s Projections and Valuation

As mortgage advancements were lower than anticipated in Q2, and given our anticipation of more aggressive rate cuts, we are lowering our 2024 revenue and EPS estimates  

We note that the MIC should be able to distribute declared annual dividends ($0.80/share) even if loan loss allowances are raised by 500%. Sector multiples are up 8% since our previous report in May 2024, and 23% below pre-pandemic levels

Our fair value estimate increased from $10.05 to $10.09/share, driven by higher sector multiples, partially offset by our lower 2024 EPS estimate

We are reiterating our BUY rating, and adjusting our fair value estimate from $10.05 to $10.09/share, implying an expected return of 21% (including dividends) in the next 12 months. Anticipating lower interest rates, we remain bullish on MIC and financial stocks. Although lower rates can compress profit margins, the resulting economic boost, higher transaction volumes, and potential for higher valuations will likely have a more significant positive impact.

Risks 

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

• Market concentration: BCF’s primary market is residential construction
• Allows borrowers to defer interest payments till maturity
• Credit and collateral 
• Timely deployment of capital is critical
• Distributions are not guaranteed
• Investments in mortgages are typically affected by macroeconomic conditions, and local real estate markets
• The company uses leverage, increasing the fund’s exposure to negative events
• Default rates can rise during recessions