Atrium Mortgage Investment Corp

TSX:AI

Earnings Call Transcript 2024-Q1

[Operator]

Welcome to the Atrium Mortgage Investment Corporation's First Quarter Conference Call. [Operator Instructions] A reminder that this conference is being recorded Wednesday, May 15, 2024.

Certain statements will be made during this phone call that may be forward-looking statements. Although Atrium believes that such statements are based upon reasonable assumptions, actual results may differ materially. Forward-looking statements are based on the beliefs, estimates and opinions of Atrium's management on the date that statements are made. Atrium undertakes no obligation to update these forward-looking statements in the event that management's beliefs, estimates, opinions or other factors change.

I would now like to turn the conference over to your host, Robert Goodall. Mr. Goodall, please go ahead.

[Robert G. Goodall, executive]

Thank you, and thank you for calling in today. Our CFO, John Ahmad, will start by talking about our financial results, and then I'll speak about our performance from an operational and a portfolio perspective. John?

[John Ahmad, executive]

Thanks, Rob. Atrium got off to a solid start in fiscal 2024 by posting an EPS of $0.27, which is pacing ahead of our fixed dividend rate $0.225 for the quarter. This is consistent with our Q4 performance but down from $0.33 in the prior year quarter.

Our Q1 revenues of $25.2 million are actually up 6.3% over the prior year due to our higher portfolio balance and a higher portfolio rate. But EPS was down due to a higher provision for mortgage losses booked in the current quarter and not a deterioration in core operating performance.

Overall, our mortgage portfolio ended the quarter at $886 million, which is down slightly from $894 million in Q4 but higher than the prior year balance of $845 million. Market activity remained slow in the quarter. Uncertain economic conditions marked by high interest rates, inflationary construction costs, financial stress on end consumers continue to keep capital on the sidelines and hence, capped the number of attractive opportunities in the market.

Benchmark rates remained unchanged during the quarter, but our portfolio rate came down to 11.25% from 11.42% at the beginning of the year. This decrease is due to loan repayment higher rates being replaced with originations at lower rates. All things being equal, we expect this trend to continue.

This trend is also consistent with our focus on low-risk forward mortgages as nearly 30% of new originations in Q1 were single-family mortgages in the GTA. This aligns with our primary objective of maintaining a resilient portfolio and protecting shareholder capital during uncertain times.

Our balance sheet also remained very strong at quarter end. Our total balance sheet leverage of 43.9% remained low, and our floating rate credit facility represented just 24.7% of total funding sources at the end of the quarter.

We still have plenty of room on our credit facility as it currently has a limit of $315 million, but this represents both a source of liquidity and potential funding capacity to grow the business should market conditions permit. Balance of our funding is mainly comprised of equity capital and our convertible debentures, which remain fixed at favorable rates with the earliest [indiscernible] this June 2024 and the rest staggered between 2025 and 2029.

Given the high rate environment, management would prefer to lock in longer-term funding at more favorable rates. Therefore, we continue to monitor the market closely where we have ample capacity on our credit facility to fund maturity if required.

During the quarter, we also booked a provision for mortgage losses of $3.9 million, which is significantly higher than the previous amount of $1 million in the prior year quarter, and this is due to a higher assessment of credit risk in our mortgage portfolio. Total allowance of mortgage losses is now 281 bps, up from 253 bps last quarter.

It should be noted that a large proportion of our allowance is for Stage 1 [indiscernible] levels. Our Stage 1 allowance represents 39% of our total allowance and remains elevated due to weak macroeconomic indicators employed in our model, including housing prices, unemployment and economic growth.

On a positive note, outside of smaller single-family loans, no new multifamily or commercial loans are classified as Stage 2 or 3 this quarter. And the total amount of loans in Stages 2 or 3 was down 14% quarter-over-quarter mainly due to paydowns.

While Atrium is not in the [indiscernible] market, our current credit profile improved slightly over the quarter. In addition, our business model continues to produce strong cash flow for investors in spite of proactively recognizing higher credit risk to our provisions.

Overall, Q1 was another consistent quarter in terms of natural performance for shareholders. We continue to adhere to our established risk appetite in terms of new opportunities and been very disciplined with respect to operating expenses, continue to maintain a strong balance sheet that could withstand any stresses from the downturn in the cycle.

Rob, I'll pass it back to you.

[Robert G. Goodall, executive]

Thank you. As John said, we had another good quarter. Atrium MIC generated basic earnings per share of $0.27 in Q1. We again increased our loan loss provision to $3.85 million for the quarter despite, as John mentioned, a material reduction in Stage 3 loans during the quarter. As you know, we've always been proactive in making loan loss provisions, which will protect future earnings.

Overall, the portfolio decreased marginally from $893 million in Q4 to $886 million in Q1. Loan advances were $78 million, and loan repayments were $81.6 million. We expect to have a high level of loan repayments in Q2. And consequently, the loan portfolio will reduce in size.

Atrium's average mortgage rate dropped slightly from 11.42% last quarter to 11.25% this quarter. This was due to the fact that a significant portion of new loans were low-risk single-family mortgages priced at 9 49 per annum.

Approximately 80% of our loans are now floating, down from 89% last quarter. Given that rates have peaked, we're no longer concerned about structuring loans on a floating rate basis. Atrium's total of high ratio loans, that is loans over 75% loan-to-value, remained low at 8.9% of the total portfolio. There are 4 high ratio loans in the commercial and multi-residential portfolio totaling $68 million. And there are also $10.5 million of high-ratio single-family loans with loan to values ranging from 75.3% to 92.2%.

Atrium's percentage of first mortgages jumped from 94.6% to 96.7% in Q1, which I believe is an all-time record high. Construction loans represent only 4.85% of the mortgage portfolio. We view construction loans as the most risky type of loan today because the frequent cost overruns and significant time delays. In Q1, the average loan to value of the portfolio increased to 64%, which continues to be within our desired range.

Turning to defaults. There were no new commercial or multi-residential defaults during Q1. I'll describe each of the loans. Our presold project in Sutton of $2.8 million then was actually repaid shortly after quarter end on April 11. A market townhouse site of $1.5 million, this project had a much larger loan. It's actually been sold and closed, and the final $1.5 million should be released in the next 3 months.

$49 million mortgage in North Vancouver. This 4.5-acre site has been in default for several quarters, and it is fully approved for a mix of multi-residential buildings having a gross floor area of approximately 300,000 square feet. Since the last quarter, the redemption period for the [indiscernible] has lapsed, and we interviewed 3 realtors. We selected CBRE, who launched the sales process in the first week of May. There is strong interest in the property, and we'll know more by the end of next quarter.

The remaining 4 loans are located in Greater Vancouver and totaled $38.5 million, and they are connected to a single sponsor. As a result of ongoing legal proceedings, I'm unable to speak in too much detail about these loans, but I'll tell you what I can.

The loans range in size from $3.8 million to $13.5 million. And all of them are secured by low-rise development sites. They're mostly townhouse sites in Langley, Richmond and White Rock. One is a construction loan, and the other 3 are bridge loans. We believe that we have potential impairments on 2 of the 4 properties. And accordingly, we've made specific provisions for those 2 loans over the last 6 months.

The final loan in default is a condo inventory loan in Vancouver. The loan was secured by 22 completed condominium units with an estimated liquidation value of about $25 million. The loan balance dropped from $20.5 million last quarter to $16.2 million at the end of Q1 as a result of 5 condo inventory units being sold. Another 4 have gone firm and will close within the next couple of weeks, reducing the loan by a further $3 million.

In addition to the condo inventory security we hold, we also have an assignment of a $10.5 million first mortgage on a parcel of land appraised at $29 million. So we definitely do not expect to incur a loss on this loan.

In Q1, we increased Atrium's loan loss reserve by $3.85 million. The amount of the quarterly loan loss reserves continues to gradually trend downwards and this for the third straight quarter. Atrium's loan loss reserve now [indiscernible] a very healthy $24.9 million, equal to 281 basis points on the overall mortgage portfolio. This is up from 253 basis points last quarter, 203 basis points in Q3 and 150 basis points in Q2.

It's worth noting that we have a large general reserve equal to 107 basis points against our highest quality Stage 1 loans, which should reinforce the notion that our loan provisioning is very conservative. As a result, we strongly believe that we have adequate provisions in place, which will protect profits for the future.

My economic commentary is as follows. After strong GDP growth in January, GDP increased by only [ 0.21% ] in February, which was well below consensus. The forecast for Q1 as a whole is 2.5% GDP growth and a seventh consecutive quarterly per capita decline.

Canadian labor market has been soft with the unemployment rate increasing by 1.1% since 2022 to a total of 6.1% today. Canada's labor market contrasts with the U.S., where employment levels have been very strong and the unemployment rate is only 3.9%.

Consumer Price Index in Canada dropped to 2.9% in March from 3.4% in December 2023. Once again, shelter costs contributed to most of the [indiscernible]. Core inflation is sitting slightly above 3%, but it is also adversely affected by the inclusion of mortgage and rent increases.

There's a growing sense that the Bank of Canada will begin cutting interest rates at the June or July Bank of Canada meeting. Consensus among economists is for a cumulative 1% cut by the Bank of Canada by the end of 2024.

Conversely, the higher inflation rate and stronger job market in the U.S. has caused economists to now forecast only one interest rate cut towards the end of 2024. Divergence in economic prosperity between the U.S. and Canada could limit how much the Bank of Canada can cut rates.

Turning to the commercial real estate markets. The pace of cap rate increases slowed significantly in Q1 with the yield [ dropping ] just 9 basis points on a quarter-over-quarter basis to 6.69%.

In the GTA, multifamily cap rates and high-rise apartments were 3.35% to 4.4%, while industrial cap rates were 5% to 5.5% and office cap rates were 5.25% to 7.25%. In Vancouver, where cap rates are traditionally lower, multifamily cap rates in high-rise apartments were 2.25% to 3.25%, while industrial rates were 4.5% to 5% and the office cap rates were 5.25% to 6.25%.

The industrial vacancy rate in Toronto rose to 3.3%, while Vancouver rose to 3.6%. Significant growth in industrial lease rates appears to have come to an end. Vancouver remained the tightest office market in Canada with a 10.9% vacancy rate downtown and a suburban vacancy rate of only 7.8%. In Toronto, the downtown vacancy rate was much more elevated at 18%, while the suburban office vacancy rate was 20.6%.

Looking at the residential resale market. In the GTA, April sales were down 5% compared to last year when there was a temporary resurgence in market activity. The number of new listings were up a surprising 47% over the same period.

The home price index in the GTA was down less than 1% year-over-year. And on a month-over-month basis, the composite index was up 0.4%, and the average selling price was up 1.5%.

In Metro Vancouver, resales in April were 3.3% above the previous year. Similar to the GTA, the number of residential properties listed for sale was up by 42%. The home price index increased by 2.3% on a year-over-year basis and was up 0.8% compared to last month.

Turning to the new home market. In the GTA, sales in Q1 were 10.9% below the same period last year. High-rise sales were down 41% on a year-over-year basis, while low-rise sales were up 76% on a year-over-year basis albeit from a low base of comparison.

The benchmark price for high rise and low rise dropped by 5.6% and 11.4%, respectively, on a year-over-year basis. But they did increase by 0.7% from the previous month. Although the supply of unsold high-rise inventory increased, 57% of that inventory is still in the presales stage and may never be built.

As importantly, there are only 525 unsold units [indiscernible] inventory, and 87% of all units currently under construction have been presold. In Vancouver, the Q1 figures are not yet available. But in Q4, Metro Vancouver's new multifamily home sales increased by 20% from the previous quarter and 58% from above the same quarter last year. The higher sales were facilitated by a greater number of projects been released to the market. A total of 40 projects were launched in the fourth quarter, representing over 5,400 units of inventory of which 38% were reported sold at the end of the year.

To summarize, resale sales volumes are below average levels, and prices are relatively flat. Not surprisingly, the new home market remains relatively weak, particularly in the GTA. We need lower mortgage rates and price appreciation in the resale market before we will see a significant recovery in the new home market.

To finish, despite continued challenging market conditions, we're off to a good start in 2024 with earnings per share of $0.27. And overall, I'm pleased with the way the portfolio performed in Q1. The Stage 3 loans dropped from $36.7 million all the way down to $18.8 million. And our combined Stage 2 and Stage 3 loans dropped by approximately $22 million.

We had no new commercial and multi-residential defaults during the quarter. Given the state of the market, I believe that there will be fewer active nonbank lenders in the future and that lenders like Atrium will benefit from the fallout. This process is taking longer than I anticipated, but I still expect that it will ultimately unfold.

For now, we're finding new loan business quite competitive in terms of both loan amount and pricing. That competition is coming from both nonbank lenders and occasionally from large banks.

For the balance of 2024, we're targeting a higher proportion of originations in the single-family sector as well as higher origination in commercial sectors. This strategy is aimed at lowering risk, the risk of any new loan business put on the books.

My sense is that the real estate markets will be soft until at least the end of [ 2024 ]. We forecast that a market recovery should gradually occur in 2025, when real estate markets have bottomed, inflation has declined and the Bank of Canada has materially dropped interest rates.

In the interim, the lack of activity is starting to result in a drop in construction costs. The most pronounced drop has been in low-rise construction where we have seen as much as a 15% drop in costs. I remain confident that our team can manage our portfolio through the balance of this downturn.

As we discussed earlier today in our management presentation at the AGM, we have consistently outperformed during market downturns. During the financial crisis, for instance, in 2008 and 2009, Atrium earned $0.98 a share and $0.99 a share. And since the beginning of COVID, we've earned $0.98 a share in 2021, $1 rate in 2022 and a record $1.18 per share last year. And we started the year again 2024 with strong earnings of $0.27 per share.

That's all for the presentation, but we'd be pleased to take any questions from the listeners.

[Operator]

[Operator Instructions] The first question is from Sid Rajeev from Fundamental Research Corp.

[Siddharth Rajeev, analyst]

Congrats on a strong quarter. I'm trying to figure out how you would -- might be forecasting allowances, currently that 2.1% of the portfolio. If there are no mortgage-specific expected losses, will you maintain this allowance at current levels? Or is it safe to assume that you'll keep increasing similar to what you did in Q1?

[John Ahmad, executive]

Sid, I'll jump in on this one. So our allowance as Rob mentioned, we have our Stage 1, which is general, which is over 100 bps, which we feel is adequate at this time. And given the softness in the market, that's probably going to persist and continue.

I would expect that number to stay at an elevated level for the foreseeable quarters. Stage 2 and 3, it's very hard to give a very precise answer to you because they're very loan specific, right? So every quarter, we're going to look at our portfolio, look at our borrowers, look at our specific situations.

Rob talked about specific loans where the collateral is coming to market. So that's going to help us understand our provisions a little more closely. So it's hard to give you precise numbers on this one, but we can say as long as the market remains soft, there's going to be pressure to keep higher level provisions.

[Siddharth Rajeev, analyst]

Okay. The second question is, obviously, rates are expected to [indiscernible] in the second half or at least by Q4. And you did mention that you could see gradual increase in new mortgages. How about your risk appetite? Would you be open to getting more of lowering your first mortgages or more geographical diversification or things like that? Any material changes in risk appetite?

[Robert G. Goodall, executive]

I don't think our risk appetite will change. However, we are looking at a second mortgage that has on property the bunch -- an industrial portfolio with a ton of cash flow coming out of it. We view it as a really good opportunity.

I don't know if we can put it together. We have -- we're just starting to talk to an institutional partner, but that would push up the percentage of second mortgages. But it's not like we've decided to change our risk profile. It's just a really good opportunity to come along. And I don't know if we'll do it or not. We'll see.

[Operator]

The next question is Graham Ryding from TD Securities.

[Graham Ryding, analyst]

Let me just start with the mortgage rates, sounds like you're increasing your mix share of -- for the family, and that's putting some lower rate mortgages into the portfolio. So we will [indiscernible] that weighted average mortgage rate should be trending down as we sort of move through 2024?

[Robert G. Goodall, executive]

I think so. The other thing is when prime went out, some of the mortgages that were already on the books had some really high yields. And when we renew those mortgages, particularly we want to keep those mortgages, we may price a little finer. So I think it will gradually come down. I don't think it will come down sharply, but I think it will gradually come down.

[Graham Ryding, analyst]

Okay. So listening to your commentary, I appreciate the color that you gave on the Stage 2 and Stage 3. I got the sense that it's the $38.5 million, 4 loans, one sponsor in GTA is the area that might have the most sort of risk from your perspective. Do you think you may have to take some impairments there? Is that accurate when you go through all the Stage 2 and Stage 3, that's the most problematic group of loans?

[Robert G. Goodall, executive]

Yes, I think you're right, but I think we're really well provisioned on them. I don't think we're going to need more provisions on them. I think there's a chance that we could recover on them. I mean we're seeing verbal interest and in one case, a written offer that would suggest we're overprovisioned. But offers don't always close these days. So we're not counting on that offer unless it goes [indiscernible].

So I think you're right that the $38 million single sponsor, the 4 loans, like 2 of the loans we're not terribly worried about and 2 of the loans we are. But we're pretty darn well provisioned on both of them. It's not like we need to catch up on the provisioning on either one of those.

[Graham Ryding, analyst]

Okay. Understood. Normally, you have pretty low loan-to-value against your margins. So why -- what happened here that 2 of them you think you may take some losses here?

[Robert G. Goodall, executive]

So one of them was a construction loan where the construction costs got completely out of hand. We have a suspicion that the cost monitor didn't do a good job of ensuring that the funds we were seeing were actually advanced to this project and not to another project because the costs don't make any sense in terms of the cost to complete.

So it put us in a much higher loan to value than we should have been. It was not just the fact that construction costs or costs have increased. There's something more than that on this loan.

Having said that, we're over 60% [indiscernible] on that loan. So we don't have much closure on, like we're taking the worst-case scenario on that one. And the other one was a project where the city changed its mind, the municipality. It isn't GTA, but I'm not going to say which municipality.

But the city changed its mind as to how they saw a particular area. And we were lending on the basis of what we understood the density would be. And that -- again, I won't get into really too granular, but there was a big surprise in terms of what the zoning looks like today versus what we expected it to look like.

And it was because the city completely reversed its position in part because of provincial guidelines that came that the city was not keen on but had to adhere to. I don't know if I'm making any sense. So sometimes you hit the perfect storm. These 2 were the perfect storm.

[Graham Ryding, analyst]

Yes. So that makes sense to me. And then if we sort of look into 2025, and we do get scenario rates start to come down and the commercial market seems to start a little bit healthier and more active, and you do see a decline in your Stage 2 and Stage 3 loans. Like assuming no material write-offs, would you be in a position there to reverse some of these ACLs that you've built up on your balance sheet and reverse them back into earnings?

[Robert G. Goodall, executive]

Yes, we could be. I mean in 2019, we thought that a 1% -- just from 10,000 feet, we saw a 1% loan loss provision on the overall portfolio was perfectly fine. Now we're at 2.81, and we've hardly incurred any losses, and we've got $24.9 million of provisions in place. So we think we're really well provisioned.

But ultimately, when the market -- and we even have, as John said, 107 basis points against our healthiest loans, our Stage 1 loans. So we think we're really well provisioned. So the question is -- I think we're in a U recovery. I don't think we're in a V recovery.

I think a lot of real estate developers are weaker than they were, obviously, 2 years ago. They've been servicing mortgages off and out of their own liquidity. And so I think the recovery will take a while.

I do think we're at or near the bottom. But it's not like they're suddenly going to be healthy at the end of all this. If they lost a lot of their liquidity, they're not going to be going and buying new projects the minute the clouds part. They just won't have the same financial capacity they once did.

So we're just being pretty careful because my sense is that, yes, the recovery should start sometime in 2025, hopefully early 2025. But I don't think it's going to be a miraculous and quick recovery. I think it's going to be a gradual one.

[Graham Ryding, analyst]

Okay. Very helpful. And one more if I could get greedy, just the convertible debenture that's coming up in June. It sounds like you're more likely paying this off with your credit facility than coming back to the market. Is that fair?

[Robert G. Goodall, executive]

I think so. I think almost definitely, yes, we're hopeful that converts will come down. They're down about 75 basis points in terms of the pricing that's been presented to us by various investment dealers, including some from your firm. So I think the market is probably 7.25-ish, maybe 7.

We wouldn't want to pay that much because convertible debentures are expensive. They come with significant broker fees. So the real cost is 3/4 of a point more or something like that. So we look as interest rates drop for some improvement in the convertible debenture market, and then I think we'd be open to access it.

I don't think we want our entire balance sheet to just be equity at line credit. We like to have converts on our -- within our balance sheet. Just because they're fixed rate obligations, they're very predictable. And I think it's healthy to have the mix of all 3 sources on your liabilities, your balance sheet, equity, line of credit and converts.

[Operator]

[Operator Instructions] It appears that there are no other questions at this time. I will now give the call back to Robert Goodall for closing statements.

[Robert G. Goodall, executive]

Okay. Thank you very much for listening to our presentation. We're not talking about it, but we're quite proud of our results over the last several years. We've now had the highest earnings per share of what we view as our peers for 12 straight quarters, and we think we're very well provisioned.

So we haven't created those earnings per share through skipping on loan loss provisions. For the contrary, we're very healthily provisioned. So to say we're not cocky about it, but we're quite proud of our results and hopefully [indiscernible] our shareholders are pleased as well. Thank you very much.

[Operator]

Thank you for participating. This conference call is now concluded. Please hang up.