Timbercreek Financial Corp
TSX:TF
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Timbercreek Financial Corp
Earnings Call Analysis
Summary
Q3-2023
The company maintained stable financial performance with net investment income of $30.3 million, equaling last year's results in the same quarter, and an increase in net income to $16.5 million from $13.5 million. Distributable income stood at $16.8 million, translating to $0.20 per share at a modest payout ratio of 85.6%. Although facing heightened challenges due to the rapid rise in interest rates and general economic weakness, the firm expects near-term increases in activity and transaction volume. Notably, 86.5% of investments were in cash-flowing properties, the largest being multi-residential assets at 58.2%. The portfolio's weighted average interest rate (WAIR) rose to 9.9% year-over-year because of central bank rate hikes. Additionally, significant progress has been made towards resolving Stage 2 and Stage 3 loans, with expectations to reduce related exposures to about 10% by early 2024. Given the firm's confidence in recovering invested capital, they foresee a positive trajectory for shareholder value.
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Good day, ladies and gentleman, and welcome to Timbercreek Financial's Third Quarter Earnings Call. [Operator Instructions] As a reminder, today's call is being recorded.I would now like to turn the meeting over to Blair Tamblyn. Please go ahead.
Thank you, operator. Good afternoon, everyone. Thanks for joining us to discuss the third quarter financial results. As usual, I'm joined by Scott Rowland, CIO; Tracy Johnston, CFO; and Geoff McTait, Head of Canadian Originations and Global Syndications. It was another solid period financially as our portfolio continued to generate strong interest income, allowing us to report solid top line and bottom line results in the quarter. Financial highlights included net investment income of $30.3 million, similar to last year's Q3; net income of $16.5 million, up from $13.5 million last year; and distributable income of $16.8 million or $0.20 per share at a modest payout ratio of 85.6%.These results speak to strong underlying fundamentals and the capability of our portfolio to generate substantial income, EPS and sustainable dividends. At the same time, this has been a uniquely challenging period for certain borrowers, caused mainly by the rapid rise in interest rates and the general economic weakness. We are now emerging from a period where central banks around the world increased interest rates with unprecedented speed to combat the inflationary environment.With that, during Q3, the team made excellent progress towards the repayment of several Stage 2 and Stage 3 loans. Scott will provide additional color in his remarks, and we have extra disclosure in the MD&A again this quarter.Higher rates and rate instability create issues across many industries. And of course, in commercial real estate, we have seen a general slowdown in transaction activity. That said, as the interest rate outlook stabilizes, which seems to be the most likely outcome in the near term, we expect to see increased activity and higher transaction volume within our portfolio. As the market rebounds and we resolve our Stage 3 loans, we look forward to putting capital at work to grow the portfolio in productive investments tied to high-quality assets valued at today's pricing reality.Before I turn the call over to Scott, I do want to briefly comment on the recent share price. We rarely use these calls for this topic. However, it's been an especially volatile equity market environment. And for Timbercreek shareholders, which includes our entire senior management team, you've seen the company's shares trade in a historically low valuation range.Our book value at quarter end was $703 million, which equates to $8.43 per share. And book value for us is a simple calculation. It's the sum of all the principal amounts of the loans outstanding. So while we appreciate the perspective that there is elevated risk today in the portfolio given the Stage 2 and Stage 3 assets, what you will hear from the team today is that we expect to recover our invested capital, and a large portion of this should be resolved in the near term. To put in another way, we're confident in the book value of the business.As we've highlighted in the past, active management is an occasional reality of our business and a requisite skillset. Over the past 15-plus years through periods of economic and financial market turbulence, our team has demonstrated the ability to effectively navigate these situations and recover capital and ensure the best outcomes for our shareholders.With that, I'll turn it over to Scott to discuss the portfolio trends and market conditions. Scott?
Thanks, Blair, and good afternoon. I'll quickly comment on the portfolio trends and origination environment, if we're going deeper on the progress with Stage 2 and Stage 3 loans.Looking at the portfolio KPIs, at quarter end, 86.5% of our investments were in cash flowing properties compared with 87.7% at the end of Q2. Multi-residential real estate assets, apartment buildings continue to comprise the largest portion of the portfolio at 58.2% at quarter end, up from 50.1% at the end of Q2 due to all Q3 fundings being multifamily loans. Portfolio remains conservatively positioned. First mortgages represented 92.2% of the portfolio, up slightly from 91.4% in Q2. And our weighted average LTV for Q3 was 67%, slightly lower than the prior quarter, which was 68.3%.The portfolio's weighted average interest rate, or WAIR, was 9.9%, up slightly from 9.8% in Q2. For context, the WAIR in Q3 last year was 8.5%. The year-over-year increase is due to the impact of central bank rate hikes on our floating rate loans, which represented 88% of the portfolio at quarter end.Our Q3 exit WAIR was 10.1%, up slightly from 9.9% exiting Q2. A higher WAIR has benefits and drawbacks, of course, is driving strong interest income from the portfolio. However, the higher debt costs also places strain on certain borrowers, especially those whose debt costs have increased much faster than rents for those with demand issues such as office borrowers, where occupancy is down considerably due to work from home policies.As a result, our portfolio has seen an increase in Stage 2 and Stage 3 loans over the past year as these issues work their way broadly through the commercial real estate industry. While Q3 typically sees reduced volume, transaction levels this quarter were also indicative of the general slowness in the commercial real estate market as buyers and sellers await more stability in the interest rate outlook.We invested $76 million in new mortgage investments and additional advances on existing mortgages. Originations in the quarter were largely centered around low LTV multifamily assets. Mortgage repayment activity was also lower in the quarter. We had net mortgage repayments and syndications of about $67 million. The portfolio turnover ratio decreased to 6% compared with 11.6% in Q2 2023. You may recall that turnover was also lower in Q3 of last year at 3.3% as rates were quickly changing at the time, causing a similar pause in activity.Looking ahead, recent inflation numbers indicate that the Bank of Canada may hold on further interest rate hikes, which is expected to create more confidence in the market, and most likely, a resumption in transactional activity. Our team continues to evaluate a decent volume of opportunities in our core multi-residential categories and industrial. Given the short-term nature of our agreements, we have the flexibility to quickly take advantage of opportunities or respond to new headwinds in a given region or asset type.In terms of the asset allocation, there were no material changes from Q2 with respect to geographic concentration. A majority of the portfolio is tied to assets in urban markets in Ontario, British Columbia, Quebec and Alberta.As Blair mentioned, over the past several months, we've made significant progress on the Stage 2 and Stage 3 loans in the portfolio. So let me spend a few minutes now on their status. As you may have read in our Q3 disclosures in August, Timbercreek and its syndicate partners successfully credit bid 3 collateral assets for which the associated mortgage investment was previously a Stage 3 loan, and now we own 100% of the real estate.These are 3 high-quality senior living properties. We've installed an experienced third-party operator and are currently in negotiation for a third-party sale that will return this investment to a performing loan with material paydown from the purchaser. We hope to have material progress on this transaction by the end of this year, and ultimately, we expect a full recovery.Moving on to the portfolio of 7 high-quality income-producing multifamily assets held in receivership totaling $146 million in exposure. During Q3, there was an offer to purchase these assets, and the process has materially progressed to the point that a sale is expected to close in Q4. The structure will see all principal and accrued interest fully repaid in late Q4 or early Q1 2024. Whether it's through this transaction or another counterparty, we remain confident that active management of the file should result in a near-term resolution of this investment.We've also seen good progress on the multifamily asset under construction that was part of the same CCAA process. The asset remained in Stage 3 at quarter end. However, a purchaser was recently selected through a bid process run by the receiver. A new purchaser will join the existing joint venture owner to complete the construction of the asset. We expect the loan to be performing in Q4 2023, including the company being made current on its interest arrears, and we ultimately expect full repayment of this loan.The Stage 3 assets at quarter end also include $15.6 million in condo inventory against an original inventory balance of $23.7 million. During Q3, we discharged $2.3 million of this inventory with more units expected to close in Q4. We are satisfied with the proceeds to date and expect to be repaid by the end of 2024.During Q3, we continued to advance the Stage 3 medical office building in Ottawa. We engaged a new property manager in Q2 with deep expertise in the market to manage the leasing strategy. Our team is confident that the intended repositioning plan will generate the best outcome for the property and the ultimate repayment of principal. At the same time, we're currently selecting a broker to potentially list the asset for sale as early as Q1 2024.Moving on to Stage 2 assets, there are 2 loans to highlight. First relates to an income-producing multifamily asset in Edmonton. This loan matured in Q2 but will be extended for an additional 12 months to enable the borrower to either sell the property or seek CMHC financing. The loan is current and we expect full repayment.The second Stage 2 entry is $53.6 million net mortgage investment on 3 income-producing office assets and 1 retail asset across 3 loans with the same sponsor in Calgary. The borrower failed to pay interest as of September, and we are currently working through our legal remedies to protect our interests. We are also in active discussions with the borrower about a potential for bearings agreement, and we will likely determine next steps in the coming weeks.While the Calgary office market has been challenging for many years, some positive absorption, planned office conversions to multifamily and the high price of oil are all contributing to some optimism for the market. In addition, the loans are structured with material paydown guarantees from nonrelated future asset sales and will reduce our loan exposure by approximately 20% or $10 million. In short, there's more news to come with these assets, but with the structured paydowns and active management, we expect to work through the situation to realize our full repayment.To summarize on the Stage 2 and 3 loans, we are making material progress towards realization of the larger positions. By early 2024, this should reduce the percent of Stage 2, Stage 3 and real estate inventory to approximately 10%.We're confident both in the quality of the underlying income-producing assets and our ability to recover our investment through active management and the range of remedies available under our agreement.The Timbercreek team is experienced, aligned and highly focused on ensuring the best outcome for our shareholders. While we work through the monetization of these assets, we're pleased that the portfolio continues to generate strong income and earnings, allowing us to continue delivering attractive monthly dividends.I will now pass the call over to Tracy to review the financial results. Tracy?
Thanks, Scott, and good afternoon, everyone. You can find our full filings online, so I will focus on the main highlights of the third quarter.As Blair mentioned, we reported healthy income levels for Q3. Net investment income on financial assets measured at amortized costs was $30.3 million compared with $30 million in the prior year. We benefited from a higher WAIR year-over-year, positively impacting the variable rate loans, offset by a lower average balance in the net mortgage investments. Fair value gain and other income on financial assets measured at fair value through profit and loss decreased from a gain of $403,000 in Q3 2022 to a gain of $231,000 in Q3 2023.We reported a modest net rental loss from real estate properties of $270,000 related to operating losses on the real estate inventory. This quarter's results include one month of net rental income from the real estate properties inventory that was acquired in August via the credit bid process that Scott noted earlier.Provisions for mortgage investment losses were $0.7 million for Q3 2023, down from $3.7 million in last year's Q3. Lender fee income was $1.7 million, down from $2.2 million in Q3 2022, reflecting modestly lower originations in the period relative to last year, although Q3 volume is typically lower, as Scott mentioned earlier.Q3 net income increased by 22% to $16.5 million compared with $13.5 million in Q3 last year. And Q3 basic and diluted earnings per share were $0.20 and $0.19, respectively, up from $0.16 in the prior year.After adjusting for net unrealized fair value gains and losses on financial assets, Q3 adjusted net income was $16.4 million compared with $13.9 million in Q3 last year. Q3 basic and diluted adjusted earnings per share were $0.20 and $0.19, respectively, up from $0.17 in the prior year.We also reported strong quarterly distributable income and adjusted distributable income of $16.8 million in Q3 2023, consistent with the same period last year. On a per share basis, we reported DI of $0.20, the same as last year's Q3, and the Q3 payout ratio on DI was very healthy at 85.6%. For Q3, we declared $14.4 million or $0.17 per share in dividends to shareholders, reflecting a payout ratio of 87.4% on earnings per share.Turning now to the balance sheet highlights. The net value of the mortgage portfolio, excluding syndications, was $1.07 billion at the end of the quarter, a decrease of $55 million from the second quarter of this year. While new investments exceeded repayments in the period, as Scott mentioned, we exchanged a mortgage investment of $64.4 million for ownership of the underlying collateral, which we intend to sell.In the meantime, the gross asset is recognized in real estate properties inventory on the balance sheet with a corresponding liability for the syndicate's 50% share of the asset in our liabilities. You will find detailed breakdown of this in Note 5 to the financial statements.The enhanced return portfolio decreased $12 million to $59.3 million from $71.2 million at Q3 2022, mainly reflecting loan repayments. The balance on the credit facility for mortgage investments was $405 million at the end of Q3 2023 compared with $361 million at the end of Q2 2023.As you may have seen in our filings, we did not meet the minimum adjusted shareholders' equity covenant at quarter end due to a higher balance of Stage 2 and Stage 3 assets, which are typically excluded from this calculation. In October, we filed an amendment to the credit facility, which included an adjustment to the minimum shareholders' equity test to include some of these assets, reflecting the fact that we have a near-term path to resolution, as Scott outlined. Shareholders' equity increased modestly to $703 million at quarter end, up from $699 million last year and $699 million at year-end 2022.Under the Normal-Course Issuer Bid program, we repurchased for cancellation 108,300 common shares this past quarter at an average price of $7.40 per share. We will continue to evaluate opportunities to use this program to acquire shares accretively.I'll now turn the call back to Scott for closing comments.
Thanks, Tracy. Before we take questions, I would like to reinforce a few key points. Firstly, with a high percentage of the portfolio in floating rate loans, we should continue to generate strong top line income, distributable income and earnings. We have made substantial progress on the Stage 2 and 3 loans and expect realization and/or resolution on several of these larger balances in the near term.As this capital is repaid, we will be in a position to evaluate opportunities for growth after exiting the previous ultra-low rate environment. With interest rate stability, we expect buyers and sellers to regain confidence in the market, which should translate into higher transaction levels broadly and new opportunities for the Timbercreek portfolio.And finally, I'd like to address our view on the portfolio and the current conditions that have led to an increase in loans in Stage 2 and Stage 3. The reality is the last few years have been challenging on real estate owners. In many cases, the COVID era resulted in a weakened balance sheet and the second part -- a 1, 2 punch -- has been the rapid rise of interest rates.Many owners have the capacity to deal with the situation, but unfortunately, some do not. What's important to understand about our business as a nonbank lender is that we do not rely on borrower credit for repayment. Fundamentally, we are collateral lenders, and it's the strength of the underlying assets that ultimately provides comfort for resolution.We have an experienced team and we have confidence in our ability to transition and exit these positions over time while optimizing the outcome for all Timbercreek shareholders.That completes our prepared remarks. And with that, we will open the call to questions.
[Operator Instructions] The first question comes from Rasib Bhanji.
If I could start on the level of portfolio activity. How do you feel about the near-term level of activity? Is it reasonable to think that transaction levels will be sort of quiet over the next two, three quarters?
Transaction activity, like new originations?
Yes, the turnover to be specific.
The market continues to be active, while not necessarily in the transactional space per the comments noted previously, but loans do continue to mature. We have seen and continue to see significant opportunities subject to liquidity that we have potential to take advantage of. I think the uncertainty remains in general, which causes the institutional first mortgage banks and lifecos, et cetera, to pull back quite substantially, which again creates opportunities for us for really good risk-adjusted returns within the current environment at this point.
And I'll just add to Geoff's answer. Generally speaking, we do continue to see that sort of 40% to 50% turnover in the course of the year, it's just choppy. So coming off, normally, we come off of a low quarter of turnover, the following quarter or the quarter after that has returned to the norm to the average. So we do expect to see more repayments and repayments for us creates loans.
And then as an extension to that question, your weighted average interest rate at 9.9% right now. How do you feel about your clients' ability to handle that level of interest rates? Would it be reasonable to say we're at close right now? And in your view, would you have to discount the rates even to release some pressure from your plan if they are entering?
Yes. I look at it a couple of ways. There's no question that rates are higher than borrowers like it to be. No question about that. The rates were extremely low in the years before COVID. So there's sort of a happy medium where our rates are 1% or 2% higher than what sort of balance sheets or borrowers would like to pay. I think that's true. Having said that, I think where they are now is achievable within business plans.So generally speaking, we're focused on transitional real estate, a couple of year product. So what people are doing now in their business plans, they're calculating the cost of that debt while their assets go through a transitional phase before they will take us out with a traditional lender. So during that phase, it's just basically, it's a cost of the business. It's a cost of the business plan that they have to account for. And we do that review as well.
And admittedly, I mean, what I'm seeing in the -- from an originations perspective, in order to reduce the overall cost of capital, you see borrowers who are rationalizing putting incremental equity into transactions to reduce leverage. We are seeing our annual partners who are finally after a lengthy period of holding on to their credit spreads through this rising rate environment, seeing some compression in their credit spreads, which oftentimes tied to lower leverage type opportunities, which again, on a blended basis, still enables us to maintain similar yields to what we've been achieving. But on an overall cost basis to the borrower that's reduced. We have had also conversations with groups and executed on transactions where there's a short-term fixed rate, lower cost note option or alternative that on a blended basis, again, gets the borrower two way of reduced overall cost of capital. But again, the good news for us is it typically aligns with reduced leverage in general as well as we offer price relief and find those solutions for borrowers.
Just my last question. The land inventory that you have, I think it's $30 million or so. Any updates over there? I don't know if you mentioned it in your prepared comments, if you did I'm sorry I missed it.
No, we didn't. It's a good point. So that was the portfolio. So it is land. There's also there's a mixed-use asset, a couple of other mixed-use assets and houses as well. So we've been doing some zoning work on that file, which we're making some material progress on actually and likely looking to start the disposition process for that file in Q1 or Q2 next year.
Okay. And I guess what's your comfort or confidence that you won't have to take any fair value adjustments in this process just for the land inventory?
Yes. We do value that like that's a fair value asset that we value every quarter. We do believe that, that's sort of represented at par value.
Our next question comes from Gaurav Mathur.
Good afternoon, everyone. Just staying on the inventory line for a moment. We saw that you've moved three properties that were subject to CCAA proceedings into your real estate inventory and you're looking for a buyer. Just two questions on that very quickly. One, what sort of buyer profile is out there that you may be interested in taking this off your hands?
Yes. So I mean the three buildings are noted. It's one project there adjacent and connected frankly. So it is one project in its entirety. There was a variety of interest, I think, in general, the group that we are in advanced discussions with as it relates to the acquisition is an experienced local operator in the retirement and multifamily, actually, I'd say, broad-based and other asset classes as well. It has a meaningful existing portfolio of assets with strong cash flow and a depth of experience in acquiring similar type assets for which optimization is required.
And that leads me to my next question. We've seen the movement in cap rates, and that's not yet stabilized completely. In light of that, do you see any further fair value adjustments on that project going forward?
No, we expect to transact in full recovery of our position.
And then just last question from my end. As you're thinking about capital allocation going forward and into the end of the year, how should we think about the lending book versus any sort of distribution increases versus the NCIB activity given where the stock is currently trading at.
Yes. I think good question, for sure. Our previous guidance on this was that we were focused on getting through the active management of the files that we've discussed today. And subsequent to that, if we continue to be in a position where we're generating cash in excess of what's required for the dividend, then the Board will evaluate options to deal with that cash. There really aren't many, obviously, either it sits on your balance sheet and you grow book value or you pay that as a dividend. If you're keeping it on your balance sheet, you have to be careful. As a mix, I mean as you likely know, we have the ability to not pay any corporate tax if we distribute all of our income. So if we do leave it on our balance sheet, we have to be comfortable that we can shelter that from a tax perspective. So the Board will look at that as we near the end of the year. But you're quite right. I mean, we're definitely generating more cash than we're paying out right now. As it relates to the NCIB, I don't think we can sit here and tell you that we're going to turn it back on. But I mean, as Tracy said, we have used it in the past, and it's a lever that we think makes sense to utilize. So maybe I'll just leave it at that. But yes, we're certainly thinking about it.
Our next question comes from [ Jaeme ].
Can you hear me okay?
There seems to be some connectivity issues. That's all the questions that we have for now. With that, I'll turn the presentation back to Blair for closing remarks.
Thanks, and thanks, everyone, for joining us today. We certainly appreciate the opportunity to update you on the activities that have gone on over the quarter and that we expect to be concluded in the months ahead. Please feel free to reach out to us directly if you'd like to continue the discussion. We're certainly more than happy to discuss what we can. Filling that, we look forward to speaking again when we release our Q4 results. And we wish everyone a good afternoon. Thanks very much. Thank you, folks.