Disclosure: Timbercreek Financial Corp. has paid FRC a fee for research coverage and distribution of reports. See last page for other important disclosures, rating, and risk definitions.
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Highlights
In Q3-2023, TF reported record EPS (up 22% YoY), in line with our estimate.
EPS growth was driven by higher lending rates (8.5% in Q3-2022, to 9.9% in Q3-2023). With inflation subsiding, financial instability on the rise, mortgage costs increasing, unemployment climbing, and consumer confidence declining, we anticipate that the Bank of Canada will initiate rate cuts within the next six months.
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
