The value of good collateral
Real estate values are expected to remain fairly stable during these volatile markets (as discussed in our April 3 update, Real Estate Resiliency, found here), let’s take a look at how the COVID-19 crisis is affecting Alitis’ mortgage investments.
A mortgage is a loan in which real estate is used as collateral. Lenders will lend money to a borrower based on their ability to repay the debt, as well as the value of the property securing the mortgage. Traditional banks and credit unions focus on a borrower’s income, credit (beacon) score and other debt servicing costs to determine the risk of the borrower and the amount they are willing to lend. Alternative lenders such as Mortgage Investment Corporations (“MICs”) look at the same metrics, but because borrowers are often self-employed, new immigrants or have had a past credit event, there is a greater focus on the value of the collateral. MICs will only lend up to a certain percentage against the value of the underlying real estate as per their own independent analysis and this plays an important role in protecting the capital we invest.
In the case of commercial mortgages, borrowers will seek alternative lenders due to their speed of execution and flexibility. In all cases, mortgages from MICs and other alternative lenders tend to come with higher interest rates. The weighted average yield on the Alitis Mortgage Plus Fund’s (“MPF”) holdings is 8.2%. It is worth noting that the yield is not the same as the average borrowing rate; it is the expected income distribution on our investments. The difference between the borrowing rate and yield is affected by leverage, management fees and other income and expenses.
The MPF currently has approximately 50% of its investments secured by residential properties, 20% commercial, 14% construction, 8% land and 8% cash. The average loan-to-value on all mortgages is currently about 63%. On average there is $37,000 of borrower equity per $100,000 of real estate value securing our mortgage. If the borrower defaults, the value of the property would have to decline by 37% before our capital is at risk. Certain lenders are being cautious and increasing mortgage loan loss provisions which does have the effect of decreasing revenues (returns) in the short-term; however, the overall impact on performance is very small.
There has been a lot of talk in the media recently about mortgage payment deferrals for people and businesses that have been negatively impacted by the COVID-19 crisis. Similar to the rent deferrals discussed in the Real Estate Resiliency update, mortgage deferral does not mean payment forgiveness. Rather, the interest owed is accrued to the mortgage balance and repaid when the mortgage is refinanced or paid off. The MICs continue to earn revenue (accrued interest) and the value of the loan the borrower is required to repay increases each month.
As of the most recent update provided by each company, investments that focus on providing mortgages on single-family homes such as Antrim Balanced Mortgage (“Antrim”) and Ryan Mortgage Income Fund (“Ryan”) have seen a relatively low number of borrowers requesting payment deferrals. Antrim has been contacted by just under 10% of borrowers looking for a 60-day payment deferral while Ryan has only had 200 requests out of 5,100 mortgages (3.9%).
For mortgages secured by residential multi-family assets, commercial properties, or construction mortgages, there have been very few deferral requests from higher quality corporate borrowers though lenders are standing by and willing to work with borrowers through these challenging times. One immediate impact of the COVID-19 crisis to lenders is the closure of the courts. Lenders use the judicial system to enforce their rights to collateral in the case of default. There will be a backlog of cases to work through once the courts reopen, but this is not expected to have a material impact to our mortgage investments in the short-term.
The March 2020 performance of the MPF was negatively impacted by the fund’s roughly 10% weighting to publicly listed MICs, specifically MCAN Mortgage Investment Corporation (“MCAN”) and Timbercreek Financial (“TF”).
MCAN reported Q4 2019 earnings on February 26, 2020 that showed 2019 earnings were 33% higher than 2018 and a 6.25% dividend increase. Under normal circumstances this would be been considered exceptional results; however, COVID-19 fears pushed the share price down 22% (including the dividend) from $16.01 to $12.18, hitting a low close of $10.51 on March 23. Assuming no change to the dividend, MCAN now trades at a 11.1% dividend yield with upside potential.
It is a similar story for TF, which declined 25.4% in March. I was encouraged after speaking with the CEO of TF, Cam Goodnough, along with the co-founder of Timbercreek Asset Management ($10 billion in assets under management), Blair Tamblyn, on March 25. They indicated that all of their mortgages were performing and that they had not experienced any notable requests for mortgage deferrals. Additionally, as one of the few lenders with capital available to lend, they are able to request better rates and additional collateral than they were able to get a couple weeks ago. Finally, an added benefit is that their financing costs have been significantly reduced thanks to the Bank of Canada’s 1.50% cut to the overnight rate. As a result, Q1 2020 earnings are expected to be strong continuing from a solid Q4 2019.
As stock prices rose through January and February, we had been selling shares of TF, but with the sharp declines over the past month, see 1-year MIC stock price chart below1, we have become buyers. We have been quite opportunistic, buying on days when selling pressure is increased. This strategy has proved to be very profitable for the fund since its launch in 2014 and right now, public investments are offering better value than private mortgage investments.
In closing, we are living in extraordinary times. We will no doubt have some ups and downs along the way, but it is our view that properties used as collateral for the mortgage investments will continue to provide good security. In the short-term, we are re-positioning the portfolios to raise cash in order to take advantage of the opportunities that will inevitably come out of this crisis.
Thank you for your trust. All the best to you and your family.
Mitchell Prothman, CFA, CFP
Senior Portfolio Manager & Head of Trading
- Bloomberg LP