Dividend Delight in a Challenging Market

• In Q3-2024,  mortgage receivables (gross) rose 2% QoQ to $926M – the highest in AI's history.  However, due to sluggish sector activity, loan advancements declined 50% YoY.
• As 86% of AI’s portfolio are floating-rate mortgages, lending rates have been falling since the Bank of Canada (BoC) began cutting rates. As a result, Q3 revenue was down 3% YoY, missing our estimate by 0.9%. However, EPS increased 4%, driven by significantly lower loan loss provisions, despite missing our estimate by 0.7%. 

• The company anticipates a material decrease in stage two and three (impaired) mortgages in Q4, and therefore, we expect loan loss provisions to continue to decrease in Q4.
• We anticipate further rate cuts by the BoC (due to slower GDP growth, high unemployment, and cooling inflation) and a rise in AI’s transaction volumes in 2025. The more favorable outlook for 2025 has led management to increase the annual regular dividend from $0.90 to $0.93/share. We were not surprised by this raise, given the low payout ratio, and the large year-end special dividend we anticipate AI is likely to distribute.
• Due to sluggish sector activity, particularly in development and construction projects, the company has been increasing its exposure to lower-risk property types, such as single-family residential and income-producing commercial properties, which should reduce portfolio risk, and yields. 
• We are adjusting our 2024 dividend forecast from $1.04 to $1.03/share, reflecting a yield of 9.1%. In our August 2024 report, we predicted a rally in MIC/financial stocks driven by lower rates, and sector multiples have since risen by 4%. We remain bullish on MIC/financial stocks, and anticipate additional rallies in the coming months as further rate cuts take effect.

Price and Volume (1-year)

Portfolio Update

Loan advancements were down 50% YoY; repayments were down 34% YoY . Net mortgages outstanding were up 2% QoQ to $902M. We believe transaction volumes will pick up in 2025, driven by lower interest rates

LTV, duration, and the average mortgage size  decreased marginally, while exposure to first mortgages increased QoQ. Lending rates decreased due to the BoC’s rate cuts in Q3; note that the 50 bp rate cut in October, along with anticipated future cuts, will continue to push AI’s rates lower 

Increased exposure to commercial development projects while scaling back on residential development projects; management is currently focusing on lower-risk property types, such as single-family residential and income-producing commercial properties

Increased exposure to ON. Stage three (impaired) mortgages increased 12% QoQ to 8.7% of mortgages, significantly higher than the historic average of 3.0%

However, management forecasts a sizable decline in stage two and three mortgages in Q4; as a result, we are lowering our full-year estimate for loan loss provisions. Loan loss allowances held steady at 3.2% of mortgages

Overall, we believe the portfolio’s risk profile remains unchanged, with three green and three red signals 

Financials

Q3 revenue was down 3% YoY, amid lower lending rates, partially offset by higher receivables, coming in 0.9% below our estimate. However, EPS was up 4% YoY, driven by lower loan loss provisions, slightly missing our estimate by 0.7%. In Q3, annual regular dividends remained unchanged at $0.90/share, set to increase to $0.93/share starting December 2024 

Debt-to-capital remained within historic levels (40%-45%), but decreased in Q4 following AI's $29M equity raise after Q3

FRC Forecasts 

We are lowering our 2024 and 2025 revenue and EPS estimates due to steeper-than-anticipated rate cuts, and the recent equity financing, partially offset by lower loan loss provisions

Our estimate for the 2024 dividend varies between $0.94 and $1.10/share, as loan loss provisions and lending rates vary

Comparables Analysis and Valuation

Comparables Analysis and Valuation

Sector multiples are up 4% since our previous report in August 2024. Our fair value estimate increased from $13.03 to $13.08/share due to higher sector multiples, partially offset by the impact of our slightly lower 2024 EPS and dividend estimates

We are reiterating our BUY rating, and adjusting our fair value estimate from $13.03 to $13.08/share, implying a potential return of 25% (including dividends) in the next 12 months. Historically, a declining rate environment has proven beneficial for financial/MIC stocks. With the BoC expected to continue lowering rates, yields are set to decline. However, we believe the risk of higher default rates is easing, and the mortgage origination market is likely to gain momentum in 2025. 

Risks

We believe the company is exposed to the following risks: 

• Diversification – over 70% of Atrium's mortgages are secured by properties in ON 
• Credit 
• A downturn in the real estate sector may impact the company’s deal flow 
• Timely deployment of capital is critical
• Investments in mortgages are typically affected by macroeconomic conditions, and local real estate markets
• Highly competitive sector 
• Like most MICs, the company uses leverage to fund mortgages
• Default rates can rise during recession

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