MCAN Mortgage Corporation reports third quarter earnings

Stock market symbol
TSX: MKP

TORONTO, Nov. 6, 2014 /CNW/ - MCAN Mortgage Corporation's ("MCAN", the "Company" or "we") net income for the third quarter of 2014 was $4.9 million, down from $9.3 million (on a restated basis for our change in income tax accounting noted below) in 2013.  Earnings per share were $0.23, down from $0.46 (restated) in the prior year.  Return on average shareholders' equity was 8.74% for the quarter, down from 18.40% (restated) in the third quarter of 2013.

Net income in the third quarter of 2013 was significantly higher than the current year due to the non-recurring benefits from our acquisition of Xceed Mortgage Corporation ("Xceed") completed on July 4, 2013.  These non-recurring items included the bargain purchase gain, partially offset by transaction related expenses, and income from a higher-yielding mortgage portfolio purchased at a discount to its net book value, which was realized primarily during fiscal 2013.  In terms of recurring items, equity income from MCAP Commercial LP ("MCAP") decreased significantly from the prior year, however securitization income increased as a result of growth in the market mortgage-backed securities ("MBS") program.

Quarterly net income decreased by $1.2 million from the prior quarter ended June 30, 2014.  The decrease is primarily due to a $650,000 decrease in equity income from MCAP and a $676,000 non-recurring income distribution from a commercial real estate investment received in the second quarter.  In addition, operating expenses increased in the third quarter as a result of certain non-recurring expenses.

Year to date net income increased to $18.3 million from $17.8 million in the prior year, primarily due to increases in mortgage interest income, income from the market MBS program and whole loan gains on sale.  These increases were primarily offset by lower equity income from MCAP, higher operating expenses and the non-recurring items noted above.  For the year to date, earnings per share totalled $0.89, down from $0.92 per share in the prior year.  Return on average shareholders' equity was 11.10% for the year to date, down from 12.56% in the prior year.

The Board of Directors (the "Board") declared a fourth quarter regular dividend of $0.28 per share to be paid January 2, 2015 to shareholders of record as of December 15, 2014.

Corporate assets totalled $1.05 billion as at September 30, 2014, a decrease of $14 million from June 30, 2014.  Activity for the quarter included decreases of $8 million in mortgages, $4 million in marketable securities and $3 million in cash and cash equivalents.

During the quarter, we continued to focus on the growth of core operations and origination activities.  We continue to grow the origination of single family mortgages through the build out of the Xceed origination platform. This resulted in the growth of the uninsured single family mortgage portfolio in corporate assets. This growth has kept MCAN active in both the insured and uninsured single family mortgage market, building our presence in the broker channel. Xceed's mortgage origination levels have continued to surpass management's expectations. On the construction side of the business, the size of our portfolio decreased slightly in the quarter as we experienced run off as projects were completed. We saw increased competition for construction loans in the single family market as the major banks attempted to reduce their exposure to condominium construction. We have been managing the construction portfolio in terms of both commitments and outstanding balances to remain within our risk appetite for this asset category.

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 decreased to $12.9 million in the current year from $14.8 million in the prior year. The decrease was primarily due to the impact of the higher effective interest rates earned in the prior year on the mortgages acquired as part of the acquisition of Xceed, partially offset by an increase in the average mortgage portfolio from $796 million in 2013 to $909 million in 2014. The reduction in higher-yielding mortgages was the primary factor in the average mortgage yield decrease from 7.32% in 2013 to 5.54% in 2014. Given the short duration of the acquired mortgages, the average corporate mortgage yield has now returned to market levels. 

Excluding the mortgages acquired from Xceed, the average yield decreased from 5.97% to 5.54%.  The balance of the decrease in the corporate yield from the prior year was due to a lower yield on our construction loan portfolio as a result of lower commitment fees earned from a decrease in its balance during the quarter. This decrease was offset by an increase in mortgage fee income as certain mortgages renew or are extended.

Equity income from our ownership in MCAP decreased to $835,000 in the current year from $2.7 million in the prior year, primarily due to a significant decrease in origination fee income in the current year.  MCAP securitized a larger portion of its funded mortgages in the current year and therefore did not recognize any associated up-front origination fee income as the mortgages remained on its balance sheet.  In addition, our equity interest in MCAP decreased from 23.4% in the prior year compared to 14.8% in the current year. MCAP's origination volumes were $3.7 billion for the third quarter of 2014, and as at August 31, 2014, MCAP had $44.2 billion of assets under administration.

Fees consisting primarily of extension, renewal and letter of credit fees earned on our corporate mortgage portfolio, increased to $744,000 in the current year from $601,000 in the prior year as a result of a larger average portfolio.

Marketable securities income increased to $558,000 in the current year from $306,000 in the prior year as a result of $131,000 of gains from sale and a higher average yield in the current year. 

Whole loan gains on sale increased to $175,000 in the current year from $86,000 in the prior year, relating to the sale of $10 million of insured single family mortgages during the quarter.  We regularly sell mortgages to third-party aggregators on a whole-loan basis with premium proceeds received at the time of sale.

The realized and unrealized loss on financial instruments decreased to $119,000 in the current year from $217,000 in the prior year. These losses relate to the hedging of mortgage funding commitments to mitigate interest rate risk. 

Term deposit interest and expenses increased to $5.3 million in the current year from $4.9 million in the prior year as a result of a $54 million increase in the average term deposit balance from $768 million in 2013 to $822 million in 2014.  The average term deposit rate increased from 2.44% in 2013 to 2.45% in 2014.

Mortgage expenses, consisting primarily of mortgage servicing fees, increased to $945,000 in the current year from $864,000 in the prior year primarily due to the increase in the average mortgage portfolio.

Interest on loans payable increased to $327,000 in the current year from $264,000 in the prior year as a result of an increase in the volume of borrowings to facilitate the warehousing of mortgages prior to their sale as whole loans or through the market MBS program.

We recorded $73,000 of recoveries of credit losses during the quarter compared to $272,000 of provisions for credit losses in the prior year.  The change from the prior year is primarily due to a decrease in the collective allowance, as the corporate mortgage portfolio decreased by $8 million in the quarter compared to an $82 million increase in the prior year.  Net write-offs were $4,000 (0.2 basis points) during the current quarter compared to $215,000 (10.8 basis points) in the prior year.

Other Income - Corporate Assets:  In the third quarter of 2013, we recognized a bargain purchase gain of $2.1 million as part of the acquisition of Xceed, representing the excess of the fair value of the net assets acquired over the consideration paid.  In addition, we incurred $874,000 of transaction and restructuring expenses.

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 $165,000 in the third quarter of 2014 compared to a loss of $917,000 in the prior year, net of a $414,000 negative fair market value adjustment on derivative financial instruments (2013 - $385,000 negative adjustment).  Current quarter activity consisted of income of $409,000 from the market MBS program and a loss of $574,000 from the CMB program while prior year activity related entirely to the CMB program.

Mortgage interest income of $3.0 million was up 150% from $1.2 million in the prior year.  The current quarter consisted of $2.8 million of income from the market MBS program and $248,000 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 $421 million and its average yield was 2.64%.  The CMB program average portfolio balance decreased significantly from $618 million in 2013 to $62 million in 2014 as a result of CMB mortgage maturities throughout 2013 and 2014, while the average CMB mortgage yield also decreased from 3.65% in 2013 to 3.29% 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 $48,000 in 2014 from $355,000 in 2013, and interest on short-term investments decreased to $239,000 in 2014 from $318,000 in 2013.

Other securitization income was $414,000 in 2014 compared to $575,000 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 assets have continued to mature.

Interest on financial liabilities from securitization increased to $3.3 million in 2014 from $3.0 million in 2013. The current year consisted of $2.3 million from the market MBS program and $929,000 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 $417 million and its average interest rate was 2.24%.  The CMB program securitization liability average balance has decreased significantly since the prior year as a result of CMB issuance maturities throughout 2013 and 2014, while the average CMB securitization liability yield increased slightly from 2.97% in 2013 to 2.98% in 2014.

The negative fair market value adjustment to derivative financial instruments of $414,000 (2013 - negative adjustment of $385,000) 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 - $59 million (CMB program), 2015 - $39 million (CMB program), 2018 - $162 million (market MBS program) and 2019 - $384 million (market MBS program).

Operating Expenses:  Operating expenses were $3.6 million in the quarter, up from $3.5 million in 2013.  Salaries and benefits decreased from $2.1 million to $1.8 million and general and administrative expenses increased from $1.4 million to $1.8 million.  The decrease in salaries and benefits for the quarter relates primarily to $514,000 of non-recurring severance costs incurred in the third quarter of 2013.  The increase in general and administrative expenses is primarily due to a non-recurring expense incurred in the current year.

Income Taxes:  Estimated taxable income was $1.6 million ($0.08 per share) in the current quarter compared to $3.4 million ($0.16 per share) in the third quarter of 2013.  During the quarter, we incurred $3.4 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 $4.1 million as at September 30, 2014 from $4.5 million as at June 30, 2014.  The total impaired mortgage ratio was 0.25% as at September 30, 2014, down from 0.30% as at June 30, 2014 while the corporate impaired mortgage ratio also decreased to 0.43% as at September 30, 2014 from 0.47% as at June 30, 2014. 

Corporate mortgage arrears and impaired mortgages were $28 million as at September 30, 2014, up from $26 million as at June 30, 2014.  The increase related to our residential construction loan portfolio.  Securitized mortgage arrears were $7 million as at September 30, 2014, up from $5 million as at June 30, 2014.

Financial Position:  Total assets were $1.72 billion as at September 30, 2014, consisting of $1.05 billion of corporate assets and $667 million of securitization assets.  

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 $2 million during the quarter. Activity for the quarter included an increase of $192 million in mortgages related to the market MBS program, offset by the maturity of CMB-related assets of $193 million.

Term deposit liabilities were $827 million at September 30, 2014, down $14 million from $841 million at June 30, 2014.

Financial liabilities from securitization were $644 million at September 30, 2014, down $4 million from $648 million at June 30, 2014.  Activity for the quarter included $197 million of new liabilities related to the market MBS program, the maturity of $193 million of liabilities related to the CMB program and $8 million of market MBS and CMB program liability repayments.

Total shareholders' equity of $221 million as at September 30, 2014 was unchanged from June 30, 2014. Activity for the quarter included net income of $4.9 million, the issuance of new common shares of $1.8 million, the payment of the third quarter dividend of $5.8 million and a decrease to accumulated other comprehensive income of $892,000.

Asset Capacity:  As at September 30, 2014, our remaining asset capacity, based on our target assets to capital ratio, was $166 million.

Outlook:  Canadian real estate markets have remained balanced this year and are expected to remain in a balanced state given that inventory levels appear to be falling as developers and builders adjust to sales activities.  The housing market continues to benefit from the low interest rate environment and stable job growth; however recent volatility in the stock market and the global price of oil could have a temporary negative influence on the market for the fourth quarter. We expect low mortgage rates and modest price appreciation to support housing demand and therefore maintain market stability.

Our strategic growth strategy remains focused on our insured and uninsured single family mortgage portfolio sourced by MCAP and through our direct origination platform of Xceed.  We continue to observe growth in this asset class and originations have strengthened over 2014 which has allowed us to grow our corporate assets, further diversify and re-balance our mortgage portfolio while optimizing returns and maintaining a lower risk profile.  Over the medium term, our target corporate asset growth rate is 10% per year.

We continued our participation in the MBS securitization market with regular issuances throughout the third quarter of 2014. To September 30, 2014, we have issued $561 million of MBS to the market and plan to continue our participation in this program.  To date, we have retained the residual economics of the MBS (the "interest-only strip") on our balance sheet.  We retain the ability to sell a portion of the interest-only strips in future periods to continue portfolio growth.  As we approach 2015, we expect the negative impact of the CMB program on net income to end as remaining issuances mature, while we expect to earn further income from the market MBS program.

We expect construction activity to moderate nationally, with Western markets showing continued strength.  The recent decline in global oil prices may impact home prices and construction activity in Western Canada in future quarters. The lower Canadian dollar should benefit British Columbia and Ontario as exports of manufactured goods and resources continue to support global growth.  We expect interest rates to remain at historic lows throughout 2015.

The Basel III Liquidity Adequacy Requirements Guidelines come into effect on January 1, 2015. To continue our preparation for the implementation of these new guidelines, we have started to assess and change the composition of our liquid assets to comply. A key modification to our liquid asset position will likely be an increase in our holdings of High Quality Liquid assets such as NHA MBS securities.

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 Third 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 in the MIC entity) 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

MCAN Mortgage Corporation, Website: www.mcanmortgage.com, e-mail: [email protected]; William Jandrisits, President and Chief Executive Officer, [phone]; Jeffrey Bouganim, Vice President and Chief Financial Officer, [phone]