Description

Timbercreek is a $600M market cap company operating as a non-bank lender of first-lien mortgages and viewed as one of the higher risk lenders among peers with shorter duration loans and higher LTV’s, sometimes providing additional capital upfront on its loans to help improve the value of the underlying assets. The company’s assets are largely split between Quebec, Ontario, and British Columbia, with some exposure to Alberta and the remaining 4% of mortgages split across a few other provinces. Since 2019, Quebec’s mix of the portfolio has been volatile moving from just 7% of net mortgages in previous years to 40% in 2022 and back down to 16% following repayments in recent quarters. Multi-residential assets make up just over 50% of the portfolio, with another ~20% retail, HSD% industrial and office exposure and some exposure to self-storage, retirement, and unimproved land. In addition to our expectations for lower yields to compress TF’s NIMs in a declining rate environment, we see two additional catalysts that will pressure today’s 0.9x book valuation:

 Thesis:

1. Payout ratio above 100% supported by one-time gain on sales signals need for a dividend cut: Timbercreek has reported its dividend payout ratio in the range of 80-100% since 2017. Upon pulling back the curtain, this is not the case. The company has historically adjusted its net income line to add back any fair value write downs made in the quarters. Accounting for these adjustments, the company is regularly not producing enough cash to fund its distribution and has consistently been around or materially above a 100% payout ratio, the adjusted “true” payout ratio in 4Q21 was nearly 600%. Further proof of Timbercreek’s inability to fund its distribution lies in its reliance on equity raises since 2018 and its advancements on its credit facility. Since 2018, equity raises alone provided over $270M for the company ($90M done in March 2024) while net of repayments, the company has been advanced $350M from its credit facilities (Downside credit facility by $110M in Feb 2024). Timbercreek has paid out $310M in distributions over the same time frame before including interest payments and buybacks. Assuming some of the assets driving fair value write-downs become permanently impaired, Timbercreek has significant challenges. 1Q24’s Adj. EPS payout ratio was 100.8% and the book is currently shrinking with rising credit challenges (next).

2. Deteriorating credit profile to unearth more impaired assets: In 2023, 56% of Timbercreek’s mortgage investments matured. Management has stated that at any point in time it is typical for Stage 2 to represent 3-5% of the value of its mortgages, yet by 3Q23 had 19.7% of its net mortgages in Stage 3 and an additional 1.3% in Stage 2 while Firm Capital had 12.6% of its portfolio impaired and Atrium MIC had 9% (Atrium is a much lower risk lender with low LTV’s). Importantly, despite double the exposure versus peers to impaired assets, Timbercreek provisioned for just 0.9% versus Atrium and First Capital provisioning at 1.5% on lower LTVs. In 3Q22, 2.5% of Timbercreek’s net mortgages were impaired versus by 3Q23 at 21% which gives a sense of just how quickly the credit profile can deteriorate. In conjunction with its 4Q22 earnings, Timbercreek reported a new addition to its Stage 3 impaired assets, a $72M Groupe Selection exposure which represents an apartment construction loan and retirement home loan. In addition, a Stage 2 loan on a medical office building joined Stage 3 alongside a pre-existing impaired Edmonton condo loan. 

During 1Q24 TF announced Group Mach had purchased its Stage 3 multi-family project which represented $146M of value in the portfolio, this was initially a Stage 2 investment relating to several multi-family loans under a single sponsor which moved into Stage 3 in 2023, yet the level of provisioning was left unchanged at 0.9% of net mortgages quarter-over-quarter. While this asset is now removed from TF’s impaired list, given Timbercreek’s comments on a ‘typical Stage 2 exposure’ combined with the extreme rate environment, elevated mortgage maturities and an alarming rise in developer defaults, we expected more mortgages to move into Stage 2 and 3. To little surprise, TF’s 1Q24 earnings results disclosed another large $110M retail loan in Vancouver made up of 8 properties moving into Stage 2 where the borrower has been strained by rising interest rates. Forbearance agreements have been signed and TF hopes to see asset sales in 2024, highlighting that the assets were not yet Stage 3 because they are not yet at the threshold of 90 days default. This puts Stage 2 and 3 assets back at similar levels relative to 3Q23 when the stock was in the mid $6.00 range. This is the third time in just a couple years that a material piece of the portfolio has seen credit challenges, raising questions of how bad the underwriting is here and/or if the provisioning is appropriate for the level of risk they are undertaking.  

TF currently trades at ~0.9x book value and we believe there is a case to be made for the share price to be >20-30% lower than it is today as the lending environment surfaces more impaired assets/borrowers. From a valuation standpoint, TF trades roughly in-line with its Canadian peers despite structurally higher LTVs with a riskier portfolio and lower margin profile. US peers that are larger in scale with LTVs in the mid 50-60% range trade at a discount to TF on P/BV despite higher yields and more stability with less risk around the distribution. We believe TF offers limited upside of ~+10% with a pathway to a $5.00-$6.00 share price (20/30% downside).

Catalyst

*Dividend cut given unsustainable payout ratio (currently started ATM). Note that nearly all  private peers have halted redemptions/ cut distributions  

*Increased provisions given deteriorating RE market in Ontario and/or continue  to shrink their book given the challenging backdrop 

*Growth in stage 2 or 3 loans in BC again after clearing through the issues of 2023