MCAN Mortgage Corporation Reports Second Quarter Earnings
Aug 13, 2014, 18:09 ET
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TORONTO, Aug. 13, 2014 /CNW/ - MCAN Mortgage Corporation's ("MCAN", the "Company" or "we") net income for the second quarter of 2014 was $6.1 million, a 36% increase from $4.5 million (on a restated basis for our change in income tax accounting noted below) in 2013. Earnings per share were $0.30, a 20% increase from $0.25 (restated) in the prior year. Return on average shareholders' equity was 11.01% for the quarter, up from 9.91% (restated) in the second quarter of 2013.
The increase in net income was primarily due to higher mortgage interest income and interest on financial investments and other loans, a smaller loss on securitization assets and whole loan gains on sale earned in the current year. These increases were partially offset by higher term deposit interest and expenses and lower income from our equity investment in MCAP Commercial LP ("MCAP") in the current year, in addition to higher operating expenses as our scale of operations has increased since the acquisition of Xceed Mortgage Corporation ("Xceed") in the third quarter of 2013.
Year to date net income increased to $13.5 million from $8.6 million in the prior year, primarily due to the same reasons noted above for the increase in quarterly income. For the year to date, earnings per share were $0.66, up from $0.46 in the prior year. Return on average shareholders' equity was 12.24% for the year to date, up from 9.34% in the prior year.
The Board of Directors (the "Board") declared a third quarter regular dividend of $0.28 per share to be paid September 30, 2014 to shareholders of record as of September 16, 2014.
Corporate assets totalled $1.07 billion as at June 30, 2014, an increase of $63 million from March 31, 2014. The increase consisted of a $44 million increase in mortgages (primarily due to the acquisition of $41 million of mortgages for securitization through the market mortgage-backed securities ("MBS") program) and a $19 million increase in cash and cash equivalents.
During the quarter, we executed a reorganization through a transfer of our equity investment in MCAP to a wholly-owned subsidiary. We estimate that this reorganization will create $112 million of additional MIC asset capacity and will generate a $23.6 million gain on sale in MCAN on a non-consolidated basis. For tax purposes, we recognize a 50% capital gain, which will have an estimated positive impact to taxable income of $11.8 million ($0.57 per share). As part of the reorganization, the estimated tax cost base of the investment was increased from $22 million to $46 million.
This reorganization and its related tax impact will be finalized by December 31, 2014. Under IFRS, the reorganization did not have a direct impact on the consolidated financial statements of MCAN for accounting purposes.
In the second quarter of 2014, our primary focus was on core operations and origination activities. We continue to grow the uninsured single family mortgage portfolio through the build out of the Xceed origination platform. This initiative is expected to grow our corporate assets and improve the asset mix to further reduce our risk profile, while optimizing returns at the same time. On the construction side of the business, we have been managing operations near our target levels in terms of both commitments and outstanding balances to remain within our risk appetite for this asset category. As noted last quarter, the spring market for housing was late in starting this year due to a harsh winter. We have seen a steady increase in construction funding activity, which resulted in an increase in this asset class during the quarter. We expect the impact of these delayed fundings to be minimal in the third quarter.
We were active in the MBS market during the quarter both on the mortgage purchase and origination sides. During the quarter, we securitized $147 million of single family mortgages through the market MBS program. Profitability levels on mortgages and MBS have continued to benefit from attractive GOC rates. The strength of the market, combined with the tightening of MBS spreads, has improved the profitability of our market MBS activities. We expect to continue our securitization activity in the market MBS program throughout 2014. Additionally, in the Xceed origination platform, we were active both in the insured and uninsured single family mortgage market, building our presence within the broker channel. Xceed has made good progress in the re-introduction of mortgage products with origination levels meeting our focus levels established over a year ago.
We separate our assets into corporate and securitization portfolios for reporting purposes. Corporate assets represent our core strategic investments and are funded by term deposits and share capital. Securitization assets consist primarily of mortgages securitized through the market MBS program, Canada Mortgage Bonds ("CMB") program and reinvestment assets purchased with mortgage principal repayments. These assets are funded by the cash received from the sale of the associated securities and are classified as financial liabilities from securitization.
Net Investment Income - Corporate Assets: Mortgage interest income increased to $12.6 million in the current year from $10.1 million in the prior year. The increase was primarily due to a $188 million increase in the average mortgage portfolio from $708 million in 2013 to $896 million in 2014, partly offset by a decrease in the average mortgage yield from 5.66% to 5.58%.
Equity income from our ownership in MCAP decreased from $2.1 million to $1.5 million in the current year. We held a 23.4% equity interest in MCAP in the prior year compared to 14.8% in the current year. MCAP's securitization volumes increased in 2014, while the prior year had higher income from whole loan sales. In addition, assets under administration and servicing fees increased from the prior year. These increases were partially offset by negative mark-to-market adjustments on financial liabilities from securitization. MCAP's origination volumes were $2.7 billion for the second quarter of 2014, and as at May 31, 2014 MCAP had $42.3 billion of assets under administration.
Fees, consisting primarily of extension, renewal and letter of credit fees earned on our corporate mortgage portfolio, increased to $493,000 in the current year from $439,000 the prior year as a result of a larger average portfolio.
Marketable securities income of $466,000 was comparable to prior year income of $488,000. Lower gains from sale in the current year were offset by a higher average portfolio balance.
During the quarter, we earned a whole loan gain on sale of $535,000, which related to the sale of $28 million of insured single family mortgages to a third party. We regularly sell mortgages to third-party aggregators with premium proceeds received at the time of sale.
During the quarter, we incurred realized and unrealized losses on financial instruments of $320,000, representing gains or losses associated with the hedging of mortgage funding commitments to mitigate interest rate risk. To the extent that the related hedged mortgages are sold, offsetting gains or losses are recognized in the period that the mortgages are sold.
Term deposit interest and expenses increased to $5.2 million from $4.4 million in the prior year as a result of a $114 million increase in the average term deposit balance from $701 million in 2013 to $815 million in 2014 and an increase in the average term deposit rate to 2.46% from 2.44% in the prior year.
Mortgage expenses, consisting primarily of mortgage servicing fees, increased to $993,000 from $764,000 in the prior year primarily due to an increase in the average mortgage portfolio.
We recorded $2,000 of provisions for credit losses during the quarter, compared to $411,000 of recoveries of provisions for credit losses in the prior year. The change from the prior year is primarily due to the reversal of a $550,000 individual allowance on an impaired mortgage in 2013. Current year activity includes amortization of $69,000 in the quarter relating to the reserve set up at the time of the acquisition of Xceed, relating to Xceed's off balance sheet securitized mortgage portfolio. This reserve is expected to be incurred over the remaining duration of the portfolio. Net write-offs were $40,000 (1.8 basis points) during the current quarter compared to $3,000 (0.1 basis points) in the prior year.
Other Income - Corporate Assets: In the second quarter of 2013, we incurred $406,000 of transaction and restructuring expenses related to the acquisition of Xceed.
Net Investment Income - Securitization Assets: Net investment income from securitization assets relates to MCAN's participation in the market MBS program and the CMB program. For further details on these programs, refer to the "Securitization Programs" section of the Management's Discussion and Analysis ("MD&A"). We expect net investment income from the market MBS program to increase as we securitize additional mortgages through this program. As existing CMB issuances continue to mature, we expect net investment income from CMB assets to decrease as the related mortgages and reinvestment assets are removed from our balance sheet.
The net investment loss from securitization assets was $110,000 in the second quarter of 2014 compared to a loss of $1.6 million in the prior year, net of a $365,000 negative fair market value adjustment on derivative financial instruments (2013 - $1.7 million negative adjustment). Current quarter activity consisted of income of $467,000 from the market MBS program and a loss of $577,000 from the CMB program, while prior year activity related entirely to the CMB program.
Mortgage interest income of $2.6 million was up 37% from $1.9 million in the prior year. The current quarter consisted of $2.0 million of income from the market MBS program and $637,000 from the CMB program, while the prior year related entirely to the CMB program. In the current quarter, the market MBS portfolio average balance was $251 million and its average yield was 2.80%. The CMB program average portfolio balance decreased significantly from $773 million in 2013 to $186 million in 2014 as a result of CMB mortgage maturities throughout 2013 and 2014, while the average CMB mortgage yield also decreased from 3.77% in 2013 to 3.54% in 2014.
As a result of a significant decrease in the average portfolios due to the maturity of CMB-related reinvestment assets, interest on financial investments decreased to $167,000 in 2014 from $550,000 in 2013, and interest on short-term investments decreased to $217,000 in 2014 from $409,000 in 2013.
Other securitization income was $351,000 in 2014 compared to $1.4 million in the prior year, consisting primarily of interest rate swap receipts. As part of the CMB program, we enter into "pay floating, receive fixed" interest rate swaps to hedge interest rate risk, however interest rate swap activity has decreased as CMB mortgages have continued to mature.
Interest on financial liabilities from securitization of $2.9 million decreased from $4.1 million in the prior year. The current year consisted of $1.4 million from the market MBS program and $1.5 million from the CMB program, while the prior year related entirely to the CMB program. In the current quarter, the market MBS liability average balance was $251 million and its average interest rate was 2.21%. The CMB program securitization liability average balance decreased significantly from $1.7 billion in 2013 to $464 million in 2014 as a result of CMB issuance maturities throughout 2013 and 2014, while the average CMB securitization liability yield also decreased from 3.16% in 2013 to 3.05% in 2014.
The negative fair market value adjustment to derivative financial instruments of $365,000 (2013 - negative adjustment of $1.7 million) relates to the CMB interest rate swaps. The unrealized portion of this fair market value adjustment can be volatile as it is driven by changes in the forward interest rate curve. From an economic perspective, this adjustment is generally offset by changes in future expected income from securitized mortgages and principal reinvestment assets that have a floating interest rate. We regularly monitor our interest rate swap hedge position to minimize our exposure to interest rate risk.
Our existing financial liabilities from securitization mature as follows: 2014 - $253 million (CMB program), 2015 - $40 million (CMB program), 2018 - $164 million (market MBS program), 2019 - $191 million (market MBS program).
Operating Expenses: Operating expenses were $3.2 million in the quarter, up from $2.1 million in 2013. Salaries and benefits increased from $1.0 million to $1.8 million and general and administrative expenses increased from $1.0 million to $1.4 million. The increase in operating expenses from the prior year was due to a significant increase in the scale of operations as a result of the acquisition of Xceed, which was completed in the third quarter of 2013.
Income Taxes: Estimated taxable income was $13.7 million ($0.66 per share) in the current quarter compared to $4.3 million ($0.23 per share) in the second quarter of 2013. The aforementioned tax reorganization of our investment in MCAP contributed an estimated $11.8 million to taxable income through the gain earned on sale on a non-consolidated basis. During the quarter, we incurred $2.6 million of up-front origination costs on mortgages securitized through the market MBS program, which are expensed for tax purposes and amortized for accounting purposes.
Credit Quality: Impaired mortgages decreased to $4.5 million at June 30, 2014 from $7.3 million as at March 31, 2014. The total impaired mortgage ratio was 0.30% as at June 30, 2014, down significantly from 0.53% March 31, 2014 while the corporate impaired mortgage ratio also decreased to 0.47% as at June 30, 2014 from 0.84% as at March 31, 2014.
Corporate mortgage arrears were $26 million at June 30, 2014, down from $38 million at March 31, 2014, consisting of decreases of $5 million in single family mortgages, $4 million in residential construction mortgages and $3 million in commercial mortgages. Securitized mortgage arrears were $5 million as at June 30, 2014, down from $6 million as at March 31, 2014.
Financial Position: Total assets were $1.74 billion as at June 30, 2014, consisting of $1.07 billion of corporate assets and $669 million of securitization assets. Corporate assets increased by $63 million during the quarter, consisting primarily of increases of $44 million in mortgages (primarily due to the acquisition of $41 million of mortgages for securitization through the MBS program) and $19 million in cash and cash equivalents.
As we securitize mortgages into the market MBS program, assets are effectively transferred from corporate mortgages to securitized mortgages on the balance sheet. The change contributes to changes in asset levels when mortgages purchased are securitized in the following quarter.
Securitization assets decreased by $76 million during the quarter, primarily due to the maturity of CMB-related assets of $223 million during the quarter. This decrease was partially offset by an increase of $147 million in securitization mortgages related to the market MBS program, reflecting new MBS issued during the quarter.
Term deposit liabilities were $841 million at June 30, 2014, up $43 million from $798 million at March 31, 2014.
Total shareholders' equity of $221 million as at June 30, 2014 increased from $218 million as at March 31, 2014. Activity for the quarter included net income of $6.1 million, the issuance of new common shares of $1.7 million, the payment of the second quarter dividend of $5.8 million and an increase to accumulated other comprehensive income of $317,000.
Asset Capacity: As at June 30, 2014, our remaining asset capacity was $162 million, based on our target assets to capital ratio of 5.75. The significant increase from March 31, 2014 was primarily due to the reorganization of our equity investment in MCAP noted above. For further information, refer to the "Equity Investment in MCAP" sub-section of the "Financial Position" section of MCAN's Q2 2014 MD&A.
Outlook: Real estate markets are expected to remain balanced throughout 2014, supported by low interest rates and steady job growth. We expect mortgage rates to remain attractive to home buyers, and the evidence of price inflation to support demand levels that are sufficient for stable housing markets.
Our focus continues to be the growth of the uninsured single family mortgage portfolio sourced from MCAP and more recently through the successful integration of the Xceed origination platform into our single family unit. This initiative is expected to grow our corporate assets, improve asset mix to further reduce our risk profile, while also optimizing returns. We intend to place greater emphasis on building lower risk assets to support lower risk, sustainable profits and enhanced risk adjusted return.
We have continued our participation in the securitization market with regular issuances through the market MBS program which commenced in the fourth quarter of 2013. To June 30, 2014, we have issued $364 million of MBS, and we expect to continue our participation in the program for the remainder of 2014. To date, we have retained the residual economics of the MBS (the "interest-only strips"). We expect to sell a portion of the MBS interest-only strips in future periods.
We expect residential construction activity to moderate nationally, with Western Canadian markets showing continued strength based on strong GDP and job growth. We see opportunity for continued growth in our core markets in Western Canada and Ontario. Interest rates should remain at historic lows, though we may see a modest increase in the latter half of 2015.
Recent CMHC changes have resulted in tighter underwriting guidelines and lower origination volumes in some mortgage products. We anticipate improved stability and modest growth in our core markets to the end of 2014. Canadian real estate markets, while at an elevated price level, are considered to be balanced and we do not expect any significant housing price adjustments in the near future.
The Basel III Liquidity Adequacy Requirements Guideline comes into effect on January 1, 2015. To prepare for the implementation date, we have started to assess and, where necessary, change the composition of our liquid assets to comply with the new guideline. A key modification to our liquid asset position will likely be to increase our holdings of NHA MBS securities, as these securities are considered to be "High Quality Liquid Assets" under the guideline.
Accounting Policy Change: On January 1, 2014, we changed our accounting policy with respect to income taxes. As a mortgage investment corporation ("MIC") under the Income Tax Act (Canada) (the "Tax Act"), we intend to pay sufficient dividends in current and future years to ensure that we are not subject to income tax. Accordingly, we elected to no longer record a provision for current or deferred income taxes within the MIC entity. This change in policy was applied retrospectively as at January 1, 2013. We believe that this change will eliminate the income tax volatility in our income statement, and it is consistent with the approach that other MICs in our industry take in accounting for taxes.
Non-IFRS Measures: The following metrics are considered to be Non-IFRS measures and are defined in the "Non-IFRS Measures" section of the MD&A: Return on Average Shareholders' Equity, Taxable Income, Taxable Income Per Share, Estimated Taxable Income, Estimated Taxable Income Per Share, Average Interest Rate, Net Interest Income, Common Equity Tier 1, Tier 1 and Total Capital Ratios, Regulatory Assets to Capital Ratio; Risk Weighted Assets, Income Tax Assets, Income Tax Liabilities, Income Tax Capital, Limited Partner's At-Risk Amount ("LP ARA") and Impaired Mortgage Ratios.
Further Information: Complete copies of the Company's 2014 Second Quarter Report will be filed on the System for Electronic Document Analysis and Retrieval ("SEDAR") at www.sedar.com and on the Company's website at www.mcanmortgage.com.
MCAN is a public company listed on the Toronto Stock Exchange ("TSX") under the symbol MKP and is a reporting issuer in all provinces and territories in Canada. MCAN also qualifies as a mortgage investment corporation ("MIC") under the Income Tax Act (Canada) (the "Tax Act").
The Company's primary objective is to generate a reliable stream of income by investing its corporate funds in a portfolio of mortgages (including single family residential, residential construction, non-residential construction and commercial loans), as well as other types of financial investments, loans and real estate investments. MCAN employs leverage by issuing term deposits eligible for Canada Deposit Insurance Corporation ("CDIC") deposit insurance up to a maximum of five times capital (on a non-consolidated tax basis) as permitted by the Tax Act. The term deposits are sourced through a network of independent financial agents. As a MIC, MCAN is entitled to deduct from income for tax purposes 100% of dividends, except for capital gains dividends, which are deducted at 50%. Such dividends are received by the shareholders as interest income and capital gains dividends, respectively.
MCAN's wholly-owned subsidiary, Xceed, focuses on the origination and sale to third party mortgage aggregators of residential first-charge mortgage products across Canada. As such, Xceed operates primarily in one industry segment through its sales team and mortgage brokers.
MCAN also participates in the market MBS program, the CMB program and other securitizations of insured mortgages.
A CAUTION ABOUT FORWARD-LOOKING INFORMATION AND STATEMENTS
This press release contains "forward-looking statements" within the meaning of applicable Canadian securities laws. The words "may," "believe," "will," "anticipate," "expect," "planned," "estimate," "project," "future," and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. Such statements reflect management's current beliefs and are based on information currently available to management. The forward-looking statements in this press release include, among others, statements and assumptions with respect to:
- the current business environment and outlook;
- possible or assumed future results;
- ability to create shareholder value;
- business goals and strategy;
- the stability of home prices;
- effect of challenging conditions on us;
- factors affecting our competitive position within the housing markets;
- sufficiency of our access to capital resources; and
- the timing of the effect of interest rate changes on our cash flows.
Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the anticipated future results expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from those set forth in the forward-looking statements include, but are not limited to:
- global market activity;
- worldwide demand for and related impact on commodity prices;
- changes in government and economic policy;
- changes in general economic, real estate and other conditions;
- changes in interest rates;
- mortgage rate and availability changes;
- adverse legislation or regulation;
- technology changes;
- confidence levels of consumers;
- ability to raise capital on favourable terms;
- our debt and leverage;
- competitive conditions in the homebuilding industry, including product and pricing pressures;
- ability to retain our executive officers and other employees;
- litigation risk;
- relationships with our mortgage originators;
- ability to realize anticipated benefits from the acquisition of Xceed; and
- additional risks and uncertainties, many of which are beyond our control, referred to in this press release and our other public filings with the applicable Canadian regulatory authorities.
Subject to applicable securities law requirements, we undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise. However, any further disclosures made on related subjects in subsequent reports should be consulted.
SOURCE: MCAN Mortgage Corporation
For further information: MCAN Mortgage Corporation, Website: www.mcanmortgage.com, e-mail: [email protected]; William Jandrisits, President and Chief Executive Officer, (416) 591-2726; Jeffrey Bouganim, Vice President and Chief Financial Officer, (416) 203-5935
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