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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the Timbercreek Financial First Quarter Earnings Call. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the meeting over to Cam Goodnough. Please go ahead.
Great. Thank you, and good morning, everyone. Thanks for joining us today to discuss the 2018 first quarter financial results for Timbercreek Financial. I'm joined by Gigi, our CFO, and I'll take you through those results now.It was a solid quarter on multiple fronts, starting with a very robust transaction activity. In fact, it was the most active quarter ever in terms of deal flow. We invested more than $250 million in the quarter, that's almost double our Q1 '17 level, which underscores the continued strong demand for our financing solutions. The quarter also showed higher portfolio turnover in syndication levels than in previous quarters, which reflected our active portfolio management in the period. We continue to build our capital base, driven by the robust transaction volumes highlighted above, completing a $45 million equity offering and exercising $40 million of the accordion feature on our credit facility. This brings the credit limit on our facility to $440 million. From a financial perspective, our distributable income or DI was in line with our expectations and within our target range, allowing us to deliver the recurring cash flow required for the monthly dividends. As we have indicated since going public, cash deals that support stable dividends are our main portfolio management objective, and thus, DI remains the metric to which we manage the business. As everyone is aware, there are timing differences between DI and GAAP earnings. EPS, on the other hand, was down over the prior quarter. The drivers of that can be summarized in 3 main areas. The first was a timing issue. As we have noted for a number of quarters, we have been transitioning the portfolio to lower-risk first mortgages against a backdrop of rising rates. The average rate for the quarter of 7%, which is for all loans in the portfolio, is in line with our expectations. As discussed previously, there is a drag on earnings as rates increase. Our cost of capital increases, of course. However, it takes time for us to pass those through to our borrowers. Despite the average yield for the full quarter coming down by about 10 basis points, we are confident in our strategy to transition the portfolio in a rising rate environment for the following reasons. Firstly, the weighted average interest rate as at March 31, 2018, on all loans in the portfolio increased to 7.2%, up from 6.9% on -- as of the end of the year. Ending the quarter at 25 basis points higher yield versus the start reflects strong yield flow, portfolio turnover and investment premium. And second, virtually all new loans year-to-date have floating-rate coupons, which accounted for 28.5% of the portfolio as at March 31. The second factor impacting EPS was the equity issuance in the quarter, which increased our share count by about 4.8 million shares. Timing, again, is a factor between receiving and investing a large amount of cash, but it also impacts other items such as lender fee amortization from previous period. The same historic lender fees, that is DI earned months ago, are now spread over a larger share count in this period. The third factor was the allocation within the enhanced return portfolio to nonyielding investments, which, as previously discussed, often exhibited J-curve type return, which cause a modest drag in earnings in the short term but will be an EPS contributor in future quarters. We look at these investments on a total return basis and, thus, prefer to monitor them year-over-year. Overall, we are very satisfied with the portfolio's performance this quarter and are particularly encouraged by the overall quality of the portfolio, as evidenced by the low number of loans requiring extra attention. Looking more closely at the key metrics for the net $1.1 billion mortgage portfolio. Our exposure to first mortgages was 93% at the end of Q1. This number is down marginally from Q4 but has been trending upward in recent quarters, consistent with our strategy. The weighted average loan-to-value or LTV was 68% in Q1, up marginally from 66% in Q4. Our weighted average interest rate on the total loan portfolio was 7%, down slightly from 7.1% in Q4, while it was at 7.4% at this time last year. This year-over-year change mainly reflects the planned repositioning of the portfolio as second mortgages have been rolled off and capital has been reinvested into the first mortgages. As I mentioned at the outset, more deals now have floating rates, which will help offset the effect of future potential rate increases. Our remaining term to maturity for the portfolio was 1 year, down from 1.1 last quarter. The short-term makeup of the portfolio is supported -- it supports our ability, rather, to recalibrate in a rising rate environment. At quarter-end, 87% of the investments was secured by properties with existing rental income, consistent with Q4, and 43% of the mortgage portfolio was secured by rental apartments. And that's across the highly stable and unpredictable cash flow streams. Part of our conservative lending strategy is a focus on urban markets, which, at quarter-end, totaled roughly 9% of the portfolio. These large centers come with greater liquidity, more exit strategy and, thus, enhance the defensive characteristics of the portfolio. It was an excellent quarter for originations. We made 10 new investments in the quarter and had 6 mortgages fully repaid. In dollar terms, new and subsequent mortgage advancements totaled $215 million and repayments totaled $182 million, leading to portfolio turnover of 17% -- excuse me, 16.2% during the quarter, up from 10.8% in the fourth quarter. These figures -- these origination figures do not include the allocations made to our enhanced return portfolio. At the end of the first quarter, our ERP or enhanced return portfolio was just under $69 million, which represented 5.4% of the total -- of our total assets, net of syndication. Included in this portfolio are the sunrise assets we acquired in Q3 of 2017. We are pleased with the progress being made on this asset -- or rather assets and continue to believe this investment will meaningfully contribute to future earnings. Overall, deal flow remains strong, and we continue to review a significant pipeline of quality investment opportunities. At year-end, the mortgage portfolio remained highly diversified. We had 118 mortgage loans with an average size of $9.6 million, an investment of that size representing less than 1% of the portfolio's total assets. Multi-residential units remained a dominant asset class at 43% of the portfolio. Retail properties is our second high exposure, representing 17%. Like with other asset categories we invest in, retail properties offer predictable cash flows. Our focus, as previously noted, is on necessity-based retail and urban infill properties, 2 segments we view as more insulated from the larger changes happening in the retail segment. Looking at the portfolio by province. Exposure is similar to last quarter as we continue to favor our top 3 markets, Ontario, Québec and B.C., which now represent 76% of the mortgage portfolio. At this point, I'll turn it over to Gigi to review the financials in more detail.
Thanks, Cam. The larger portfolio drove an increase in interest income and in income from operations, which rose to $18.6 million from $17.5 million in the same period last year. This increase was largely offset by higher expenses, in particular, interest cost reflecting our increased leverage in both credit facility and debentures. Over time, we will get the outstanding benefit of higher rate on new loans, which take time to work through the portfolio. As a result, net income was down quarter-over-quarter. I will now take a closer look at the earnings and cash available for distribution. We earned $0.15 in net income per share in Q1 and had $0.18 of distributable income per share. Based on our dividends paid in the quarter of about $0.17 per share, our payout ratio on distributable income was 99.1%. As Cam mentioned, while DI fell within our target range, there were some impact on EPS this quarter. Turning now to the balance sheet highlights as at March 31. The combined and net portfolio is $1.1 billion, as Cam mentioned, up $33.8 million from Q4 and up $115.3 million from Q1 2017. At the end of Q1, we had drawn about $360 million of our $440 million mortgage investment credit facility. That number is, of course, fluid as we balance new loans and repayments. In addition, we had about $31 million outstanding on a credit facility associated with investment property. In aggregate, these are about $2 million lower than Q4. And I will now turn the call back to Cam for additional color.
Thanks, Gigi. As we highlighted at the start, the metric we've tracked most closely and, frankly, managed the business through is distributable income, which drives recurring cash flows and support the monthly dividend. Looking back since the merger in 2016, you can see that our quarterly DI has remained stable at around $0.18 to $0.19 per quarter. The financials include a detailed distributable income reconciliation, but here's a short summary of the accounting treatments that result in a divergence of DI and EPS, factors which don't impact the fundamental cash earnings power of the portfolio. The net differences between cash funded or fees earned versus the accrual of those fees over future quarters has an impact quarter to quarter, as you can see. In terms of other items, it largely relates to the amortization of capital markets fees and an accretion expense that accounting standards applied to convertible debentures outstanding. Looking ahead, our outlook remains positive. Valuations in the commercial environment, despite marginal rate pressures, remain stable. As we discussed on our last call, we are seeing greater competition in lower-risk categories such as multi-res, which reflects the impact of [B-20] and appeal of lower-risk assets, most notably, in the GTA and surrounding area because of low vacancy, increasing demand and little purpose-built rental development underway or recently online. In general, there is more institutional debt capital available for income-producing commercial assets because of their lower-risk profile. It's important to note that we are not moving up the risk curve in this environment. Rather, we continue to work hard to fund transactions that meet our parameters, and we continue to compete on customization, speed of execution and service. These are the reasons 2/3 of our borrowers are repeat clients. We are fortunate to have a strong presence and reputation in this market, and our pipeline of new opportunities remains healthy. Also, we are national, which is a differentiator and gives us the ability to be flexible as circumstances change on a local scale, whether it's oil prices in Alberta, foreign buyers in B.C. or new regulatory constraints in places like the GTA. The effect of increased competition and rising rates -- interest rates has placed some pressure on spreads in the near term. However, as noted, we are making progress on this front, as evidenced by the 0.25 point upward movement in average portfolio rate at the end of the quarter versus the start of the quarter. In addition, the increase of floating-rate loans will help buffer the impact of potential future rate increases. Finally, we took an active role in portfolio management this quarter. We opportunistically pruned some investments, which freed up investable capital to redeploy at higher rates and earn additional lender fees. We will continue to evaluate all of our investments and reposition when we see opportunities, always with an eye to the changing market and competitive landscape. Fundamentally, we continue to believe that lower-risk commercial assets provide the most attractive risk-adjusted returns for our shareholders.In closing, the company continues to be well positioned to provide investors with steady monthly income from a conservatively positioned, well-diversified portfolio of institutional quality mortgages and other investments managed by one of Canada's largest and most experienced real estate-focused investment managers. That completes our update today. But prior to opening the line for questions, I would like to note that we are joined by Ugo Bizzarri, the Chief Investment Officer of Timbercreek Asset Management. And so now I'd like to, operator, ask if there are any questions on the line.
[Operator Instructions] Your first question comes from Marko Kais with TD Securities.
It looks like the interest income did not keep up with the higher financing costs this quarter. I was just wondering about the level of expansion in your weighted average interest rate that you need to offset the higher borrowing costs. Like is that being achieved presently? And if so, how long before it starts flowing through the weighted average rates?
Sir, there's some reverberation on the line. It was a little tough to pick out the question. Could you repeat the question?
Yes, sure. Just wondering what kind of expansion in weighted average rates you need to offset your higher borrowing costs? Like are you achieving that presently? And how long before it flows to the weighted average rates?
Right. I think what I would start by saying is that if you think about our capital structure, I'm just going to use rough estimates on our total assets at about $1.2 billion, there is about, roughly, just shy of $700 million of equity capital, another $170 million of convertible debentures. Think of those 2 as a set distribution or a coupon on those. And then the -- and so what we're really dealing with is about a $400 million credit facility that has a floating rate. So that's about roughly 1/3 of our capital base has -- is affected instantly by changes in interest rates. So that's really what the effect on our interest cost, that we need to think about how do we balance the effect on the overall portfolio. So I think at the start of the quarter versus the end of the quarter, there's a different answer. At the start of the quarter, we had far fewer floating-rate instruments in the portfolio. And so you'd be -- the discussion would be mainly around how do you turn the portfolio and how quickly do you turn enough of the portfolio to recalibrate at the higher rates and how quickly can you pass through those rate increases to your borrowers and whether -- how accepting they are. And you've got a lot of competitive environment to balance there as well. But by the end of the quarter, given we're now at 28.5% of floating rate, it's really starting to approach a similar-type level as our floating-rate component of our capital structure. So we should end -- and the average term has come down slightly. So all that said, I think the biggest determinant is not so much matching, but it's a competitive discussion around the marketplace and acceptance at the borrower level.
Okay. That was helpful. Are you able to give us a sense, what are you pricing the variable-rate loans? What reference rate and spread are you using?
Would you know -- I'm just going to turn the call to Ugo to answer that.
Yes, every one is a little bit different, depending on the asset class, but we're moving the rates, especially when we're pricing. And we were up 25 to 50 bps. But for example, multifamily is going to be in the roughly -- in the 5%. But overall, the blended rate for the whole portfolio for first mortgage is around [ plus 6.3% ]. So that's an all-in rate, and then we price that to get to that -- on the variability floating rate to that rate.
Okay. And then just lastly, is there any arrears currently in the portfolio? And maybe could you give us an update? I think last quarter, there was a $60 million loan that was in arrears that was still being carried. Just wondering what happened to that.
I think there's currently 1 loan in arrears for an amount of -- and it's 30 days in arrears of $11,000.
It's really immaterial.
It's immaterial.
Yes.
[Operator Instructions] Your next question comes from Victor Dri with National Bank Financial.
So just looking at -- so in the financial statements, just a quick question here. There's a -- I think it's Note 4(a). It's just talking about -- I just want to know, is that loan -- was that loan there originated and syndicated in this quarter? Or is that from the previous quarter? It's the Page 10 of the financial statements.
The arrears? It was [indiscernible].
No. Which one? Sorry, we're just finding which one you're talking about. Can you go through that again? Page 10 on the financials?
Yes, 4(a), Note 4(a). Yes, exactly, that's the one.
No, which one are you looking at there?
Can you repeat your question?
Yes. Like that's -- sorry, that mortgage to be syndicated, is that from this quarter?
Which mortgage? Are you talking about the $55 million?
Yes.
The $55 million, the ones that's being carried at fair value through profit and loss?
No it's not from this quarter. It's from prior quarters.
It is from prior quarter, okay.
Yes. So while we adopt IFRS, we have reclassified -- as you know, we reclassified our mortgage between solely for principal and interest, which are carried as amortized cost, and so that do not meet that standard and follow fair values through profit and loss.
Okay. So did that get reclassified from amortized to fair value?
Yes, but that portion, $55 million, in particular, is not -- it's part of the overall gross loan that we have out. And that's the syndicate portion, which actually does not have any participation feature with it. It's actually at a fixed rate. But because how we present our financial statements, we show the gross and then we net out the syndication. So the whole thing is being re-classed as opposed to just a portion of it.
Okay. So it wasn't reclassified because of any impairments or anything like that?
No, it's not. No, it's not.
Okay, great. That's perfect. And then just following on that, can you give us some color on those loans that are classified as Stage 2? Like would these have been -- I know that's from IFRS 9, but would these have been Stage 2 in 2017 if IFRS 9 was in place in 2017?
I think it would, for the most part, it would.
It would, okay.
Yes.
Okay. And then I also noticed there was an increase in the exposure in Alberta, and I know you guys have been talking about [indiscernible]. I mean, can you just kind of give us some things that you look at, some factors that have improved that's driving that increase?
Well, for a long time, Alberta was a market that we like, but it was pricey. It's come down. We think there's value in Alberta right now. It has stabilized from an economy and a risk point of view, and we're seeing more opportunity there now than we had in the past.
Right. And is there anything that would keep you on the sidelines that you're kind of still keeping an eye on, that's keeping you a little bit more cautious?
As a general theme, we think it's -- every real estate asset or every real estate loan that we look at is under an individual basis. Generally, we're still -- we like multifamily sector in Alberta still. We like the industrial sector, and Alberta is picking up. We do like -- office is something that we would be more cautious in the Alberta market right now. And in retail, we do like retail. But as Cam mentioned, we like more retail assets that are focused on service or needs than the general -- the large retail classes, so...
Large and multi-type formats.
Yes.
Right, right. Okay. That's good. And then last one for me is just a couple -- just a looking-forward question to Q2, if you guys can just give us some idea of how Q2's shaping up. And then that's it for me.
Well, I would say on -- much the same as we're coming out of the first quarter. We continue to -- a phrase you heard me use a few times on the call today, more active portfolio management. I think that's a theme in this market where we are -- we have, as noted, seen some increase in competition. We need to be more active. It's not just a buy-hold-mature type strategy. We need to review continuously and prune to free up -- to increase the volatility -- not volatility, not in a bad way, but the volume of transactions that we can do generating more fees. So we are actively looking ways to manage that portfolio in a way that will allow us to reinvest and generate additional returns. And we continue to manage that through the second quarter. One thing that was noted in the press release -- we didn't mention it in our call. And it's going to happen not in Q2, not specifically in the quarter but potentially at the start of Q3, was the repayment of an outstanding converts that are due in less than a year. And the thought process there is simply that we'd like to not be tied to a specific date on maturity. So it's always been our intention, as it is most, to find an opportunistic time in advance of that date to call at par. And there is, at the moment, significant savings in rates between what we would draw on the bank facility relative to the rate that we pay on those convertible debentures. At the same time, providing us flexibly at a future date based on opportunities we see that -- in terms of either rate or term that match a convertible debenture-type financing that we could do something in the future. We're just not tied to specific dates. So now all that is subject to lender consent, I would note, for which we are intending to approach the banks if we have to do that. And our intention, our plan at this point is to do so in -- to execute that in early July.
You next question comes from Johann Rodrigues with Raymond James.
I just had one question. I wanted to get a sense of how your borrowers are feeling about the broader macro environment. I assume at the beginning of the year, coming off that rate hike, I assume that's when you kind of got above your repayments, and that was the reason. But I think your debt has been so much soft since then. And so do your borrowers have a newer expectation of the economy and how strong or not strong it is?
I would comment in general that the book we're seeing a tremendous amount of deal flow, and I think from a borrower's perspective, since most of our businesses come from repeat borrowers, there's still very much optimism in the general economy. Toronto is particularly driving the sort of the real estate in Canada. And there seems to be a lot of opportunity by a lot of the borrowers, especially since most of the borrowers are more value-add and they're looking to create value, we don't see, really, cap rates moving or they have not moved in the last 6 months. Even though rate hikes have gone up, it's been fairly stable. In general, I would just to sum it up. I think it's still fairly optimistic. And there seems to be a lot of domestic capital going into commercial real estate right now. And there's a fair bit of appetite from institutions, pension funds and institutional capital such as our borrowers that would like to get into more real estate, and they're trying to find those opportunities. But generally, it's very optimistic, so...
Right. And so, I guess, if they're feeling that way, that would imply more rate hikes. And so would you expect that the turnover would stay kind of high throughout the balance of the year versus last year?
I'm trying to think through it as we go forward. Johann, it's a fair question. It may end up being higher than last year, but it's probably not sustainable at the first quarter turnover rate. I wouldn't take the first quarter turnover rate as an indication of what we're going to look for here. There was -- there were -- there was more, as I said in answering the last -- there's more active portfolio management in this quarter than there had been historically. So I wouldn't take that as a run rate for the next quarter or the quarter after.
There are no further questions queued up at this time. I'll turn the call back over to Mr. Goodnough.
Great. Thank you, everyone, for taking the time to participate on the call today. If there's any other questions, please feel free to reach out to us directly. Thank you once again.
This concludes today's conference call. You may now disconnect.