A Narrow Window to Lock in an 11%+ Yield

Report Highlights

Mortgages outstanding (net) were down 4% QoQ to $1.07B, amid dampened real estate activity. We anticipate transaction volumes will pick up in 2024, driven by lower interest rates.

Property developers and owners have been hit harder than consumers due to high borrowing costs, low pre-sales, and dampened real estate activity. As a result, TF’s stage two and three mortgages (impaired), and real estate inventory, increased by 24% QoQ to $346M (30% of the portfolio), spread across 140 properties. TF anticipates that two-thirds of these investments will be resolved by Q1-2024. In the earnings call, management noted that that in the event of needing to foreclose on collateral assets, there would be ample equity remaining to enable TF to recover the vast majority, if not all, of its invested capital. We find this realistic, given that the majority of these properties are cashflowing/multi-family. In addition, TF has first priority on most mortgages. We note that management’s conviction is evident in their decision to allocate only 0.94% of the portfolio (down 12 bps QoQ) to loan loss allowances.

We maintain a positive outlook on the Canadian multi-family residential real estate market (TF’s primary focus), driven by robust rental demand, elevated residential property prices, high mortgage rates, and a growing influx of new immigrants, and international students.

We believe TF will announce a special dividend later in the year. Our 2023 dividend forecast of $0.72/share, reflects a yield of 11.0%. Sector multiples are down 9% since our previous report in August 2023. On average, TF’s P/E (forward), and P/B are 11% lower than that of comparables. We believe the current price level presents a narrow window to lock in an 11% yield.

Financials

Note that the above figures may be slightly different from the figures reported by TF due to the difference in the method of calculation. We used the average of the opening, and year-end balance of mortgages outstanding, and invested capital, to arrive at the above figures.







Asset / Capital Structure

Q3 EPS was up 22% YoY, in line with our estimate

Annual dividends remain unchanged at $0.69/share, implying a yield of 10.5%

As EPS grew, while monthly dividends remained flat, the payout ratio was unusually low in Q3-2023; we believe TF will announce a special dividend later in the year 

Debt to capital was up 1.1 pp QoQ

Portfolio Update


Source: Company/FRC

Mortgage advancements were down 15% YoY

Repayments were up 61% YoY

Mortgage receivables (net) were down 4% QoQ

The average mortgage size was down 5% QoQ

Exposure to income producing properties decreased, but remains in line with the historic average 

Exposure to single/multi-family and retirement properties (low-risk segments) increased  3 pp to 65% 

Exposure to first mortgages increased slightly

Source: Company/FRC

Reduced exposure to ON

LTV was down 1.3 pp QoQ

Source: Company/FRC

Lending rates continued to increase

Stage three (impaired) mortgages, and real-estate inventory, increased 24% QoQ to $346M (30% of the portfolio)

Although TF is not expecting any material losses from their impaired mortgages, for conservatism, we are projecting $8M (0.6% of the portfolio) in loan losses (previously $6M) in the next 12 months

*Red (green) indicates an increase (decrease) in risk level; ‘-‘ indicates no material change

Source: FRC

In summary, we believe the portfolio’s risk profile has increased due to higher stage three mortgages, and real estate inventory; as noted earlier, TF anticipates that two-thirds of these investments will be resolved by Q1-2024

FRC Forecasts and Valuation

 

Source: FRC

We are maintaining our 2023 EPS forecast, but lowering our 2024 EPS forecast to account for higher loan loss allowances

Our estimate for the 2024 dividend varies between $0.66 and $0.77/share, using various YoY increases in loan loss allowances

Source: S&P Capital IQ / FRC

Sector multiples are down 9% since our previous report in August 2023, and 33% below pre-pandemic levels

On average, TF’s multiples are 9% lower than their comparables

Our fair value estimate decreased from $10.01 to $9.67/share due to lower sector multiples, and as we lowered our 2024 EPS forecast

We are reiterating our BUY rating, and adjusting our fair value estimate from $10.01 to $9.67/share, implying a potential return of 58% (including dividends) in the next 12 months. Key risks include a softer mortgage origination market,and higher default rates. As we expect rates to start declining within the next six months, we anticipate an increase in appetite for high-yielding stocks, such as TF. We believe the current price level presents a narrow window to lock in an 11% yield.

Risks

We believe the company is exposed to the following risks: 

1. Operates in a highly competitive sector

2. Timely deployment of capital is crucial

3. Credit 

4. A downturn in the real estate sector may impact the company’s deal flow

5. Geographical concentration 

6. Distributions are not guaranteed 

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

8. Although the MIC’s primary focus is on first mortgages, it may invest in second mortgages which carry higher risk 

9. Default rates can rise during recession