Trez Capital Mortgage (TZZ.TO) – Liquidation – 20%+ Upside

Current Price – C$2.40

Liquidation Value – C$2.89+

Upside – 20%+

Expiration Date – TBD

Q1 2018 Financials

 

TZZ is Canadian non-bank lender investing in commercial and residential mortgages. Since 2016 the company is in orderly liquidation mode and has already sold down majority of its portfolio and distributed the proceeds to shareholders. At the moment there are 5 mortgages remaining (+1 in default) on the portfolio with net value of C$35.5m – these mature or are expected to be sold by the end of 2019. BV per share (after taking into account open market buybacks during Q2 2018) works out C$2.89 which is 20% upside to the current share price.

So far the liquidation has proceeded smoothly and management has promptly distributed any available proceeds to shareholders through special and regular dividends, tender offer and open market repurchases (below BV). If the remaining mortgages get sold prior to their maturities, then liquidation of the company will happen earlier. Until then interest from the remaining mortgages is expected to cover admin expenses and the wind-down costs – income from non-past due mortgages is c. $190k per quarter whereas admin expenses stood at $135k in Q1 2018. The remaining performing mortgages (C$33m) are probably not yet sold specifically to support any admin expenses before the final wind-down.

Future management incentive fees are already provisioned and take into account current BV of net mortgages (my calculations show potential additional incentive fee of only C$70k).

 

Problematic loans and fadditional upside

Company has 2 past due mortgages and one in default.

2 past due loans (C$6.4m gross with C$0.4 provision) are expected to be repaid shortly (partial payment made already), however two extensions have been made.

Two mortgages with the same borrower with an aggregate carrying amount of $6.4 million (December 31, 2017 – $6.4 million) were not performing and were past due on their maturity dates. Subsequent to the year end, the borrower made an offer which the Manager accepted where the borrower made a $0.6 million loan repayment in January 2018, and agreed to repay the loan in full with interest by the end of March. The borrower asked for an extension of the March date to allow additional time to arrange alternative financing, an expected repayment date of May has been set. Currently there is a fair value provision on the properties totaling $0.4 million (December 31, 2017 – $0.4 million).

If the loan get’s repaid and provision is reversed, that is an additional C$0.04/share in liquidation value.

Another loan is in default since Q2 2017 (C$3.4m fully written off) and the mortgaged property is currently being sold.

In the second quarter of 2017, a mortgage went into default when a borrower breached the terms of a forbearance agreement. The Manager took legal action and a receiver was appointed. The property was marketed for sale and bids were accepted in Q1 of 2018. Management reviewed the offers and is currently pursuing and negotiating the most attractive offer. The total fair value adjustment recorded on the property is $3.4 million (December 31, 2017 – $3.4 million).

Any recovery from the sale of the property for TZZ would mean additional upside for shareholders – every $1Cm equal to C$0.1/share.

I would expect outcome on both of these situations to be announced together with Q2 results expected in mid August.

 

Risks

  • Currently performing loans might run into difficulty and further problems might surface regarding the two past due mortgages. However, average portfolio LTV is 92.7% and the interest rates charged are very low (2.25%) so I assume the portfolio is considered quite safe.
  • There might be additional liquidation expenses that will not be sufficiently covered by the ongoing income from mortgages. However, management so far has acted in the interest of shareholders and I would expect them to continue to minimize any fees. If additional C$1m is required to wind-down of the company, then liquidation value drops by C$0.1/share.
  • Liquidation might take longer than expected, if any of the problematic loans do not get resolved by the end of 2019. Q2 management commentary on the portfolio should shed some light on this.
  • Stock liquidity is low.

25 COMMENTS

  1. work 22

    Some other comments/questions if you don’t mind:

    1) Usually the last assets of a liquidation are the most difficult to sell and that’s why they are still on a company’s books. My guess is the mortgage extended twice is a dud. Mgmt could have covered ongoing admin expenses with cash from previous sales instead of holding on to income generating mortgages. What’s left, the CAD 33 million in mortgages, might have to be discounted a bit further for investors to justify holding this. Its probably what they couldn’t sell and had to ride out. Obviously I don’t know for sure, but a humble guess.

    2) I would definitely add CAD 1 million in possible admin expenses as a cushion in valuing TZZ, and doubt that mgmt would act to minimize fees and save every paper clip and lunch expense. The last bits of money in these are usually gone, not saved. No chance of tracing it all or much accountability. The liquidation may also drag out a bit.

    3) Any more info on what the 5 mortgages are?

    4) Recovery on the 3.4 million mortgages and capturing all of the 33 million CAD in mortgages on the books seems like the hoped for outcome here. I’m just trying to factor in the downside if what’s left is garbage or truly performing and held for some reason I don’t know or understand.

    1. dt

      1) My theory is that management is holding on to these C$33m of performing mortgages in order to clean up the rest of the book, especially the non-performing ones. But you might be right – maybe noone wants to buy these last bits. Without knowing what these mortgages are, it is hard to tell. Also, keep in mind that so far every single quarter management was liquidating part of the portfolio, so there might be a limit on how much physically can a small team achieve. In any case these last loans might not need to be sold down at all, they might just get repaid at maturity (end of 2019).

      2) I am tempted to be more optimistic here, as management’s steps so far really seem to be shareholder value oriented and liquidation is going quite smoothly. However, if additional C$1m is required to finalize liquidation (on top any any income generated before the final loans are sold/repaid), that would be c. C$0.1/share.

      3) No info on what these mortgages are.

      4) My expectations on recovery of performing loans are unchanged. The past due loans of C$6.4m might be recovered partially (there is property backing it with more than loan value). And the C$3.4m loan has already been fully written off, so any recovery on it from the collateral sale, would be pure upside.

      I think the worst case scenario is that only half of the C$6.4 past due loans is recovered, liquidation drags out by another year and management’s spends additional C$2m on it. In this case BV would drop by C$5.2m and final liquidation value results in C$2.45/share. So ignoring any time value of money, there does not seem to be much downside.

      1. work 22

        thanks dt for the response. i agree, not much downside, possible upside.

      2. W51W52

        The loan that is in default is the $20.454 million (gross) loan that is >$10.0mm, per the MD&A. See the following language in the 12/31/17 financials: “A loan previously classified as in default was resolved through acquisition of the property by an affiliate of the Company for the total consideration of $23,030,559. On February 5, 2016, the affiliate of the Manager sold the property to a third party for $24,900,000, which was partially financed by a vender take-back (“VTB”) in the amount of $23,400,000. At the time, an affiliate of the Manager also agreed to supplement the interest rate to be 6.5% for the first three years. As a result of the Orderly Wind-Up, the affiliate of the Manager ceased to supplement interest on the VTB. On September 1, 2016, the Manager issued a demand on the loan due to unpaid legal fees and property taxes.

        Subsequently, the Manager entered into a forbearance agreement with the borrower on the basis that all loan payments and property taxes in arrears are brought up to date. The borrower made all interest and principal payments up to July 2017 but has since breached the agreement and the Manager took legal action. The Manager appointed a receiver, who enlisted a broker to market the property for sale with bids to be submitted by February 27, 2018. Management is reviewing and considering the offers received to date. The total fair value adjustment recorded on the property is $3,395,000.”

        1. dt

          Thanks W51! Had a look at Q4 MD&A, but somehow did not connect the dots.

          TZZ disclosures are a bit confusing. It seems that the loan in default (the one with C$3.4m provision) is included among “2019 and beyond” instead of “past due”. So my comments that the defaulted loan has already been fully written off, are incorrect.

          However, this does not change the investment case, and I think actually helps it:
          - The sale of the property relating to this C$20m mortgage likely closed already or is expected to close shortly (management’s comment in May “currently pursuing and negotiating the most attractive offer”). This pulls the liquidation timeline much closer.
          - Even if current buyers walk away, there were 8 bids in total thus sale of the property should not be problematic.
          - The C$3.4m provision recorded on mortgage dates back to 2016. If currently expected sale proceeds were not sufficient to cover the net mortgage amount, then management would be forced to record additional provision. However, this does not necessarily need to happen in the opposite scenario – when sale proceeds are higher than the net mortgage amount, provision might not need to be revised downwards. Thus potential upside remains.

          Q2 disclosures will surely clear things up.

        2. work 22

          Thanks, i missed this too- they kind of snuck that in there in the March 2018 financials, mentioning only the 3.4 million provision and the total carrying amount of 20 million! But they did mention as below that “bids were accepted” so hopefully not too bad of a writedown there either. See anything else we should be paying attention too?

          From the March 2018 financials:

          4. Investments in mortgages (continued):
          (b) Default or past due mortgages (continued):
          (ii) In the second quarter of 2017, a mortgage went into default when a borrower breached the terms of a forbearance agreement. The Manager took legal action and a receiver was appointed. The property was marketed for sale and bids were accepted in Q1 of 2018. Management reviewed the offers and is currently pursuing and negotiating the most attractive offer. The total fair value adjustment recorded on the property is $3,395,000 (December 31, 2017 – $3,395,000).

  2. work 22

    Good news is out today August 14th. Nice call dt. Wish it had been more liquid, was only able to scoop up a small amount. But anyway nice one

  3. dt

    Good news indeed:

    - C$2m of provision reversal;
    - Special dividend of C$2.4/share to be paid in September (which is equivalent to the stock price at the time of the write-up);
    - New liquidation value stands at C$3.05 (after incentives fees and assuming zero liquidation costs);
    - All problematic mortgages have been resolved;
    - Only one mortgage left in the portfolio and this one pays 6% interest rate (generating C$75k per quarter) and matures in Q1 2019. So liquidation timeline has been pulled forward.

    The biggest question mark at the moment is admin expenses before liquidation and for the final wind up of the company. At current prices (C$2.64/share) these expenses would need to be C$5m (or entire amount of the single remaining loan) for TZZ shares to breakeven. I think this is way too conservative.

    1. work 22

      Are you estimating C$900k in performance fees? (page 11 of the 2Q MD&A: At June 30, 2018 the remaining estimated amount of the future incentive fee obligation is $0.9 million. The provision has been estimated using the projected realized proceeds at the current fair value of investments in mortgages and management’s best estimate of expected repayment dates)
      Where did you see the C$2M of provision reversal? And is that C$2 million provision reversal being dropped into the C$2.40 return of capital, or held for the final payments?
      After the C$2.40 payment of course the rate of return on investment accelerates quite a bit….

      thanks again!

      1. dt

        Management incentive fees have been updated to reflect higher proceeds than previously expected from the 3 problematic loans. Approximately 20% of the $2m provision reversal.

        Re reversal, do not have the docs in front of me, but its in MD&A.

  4. work 22

    Earlston Investments has offered to buy TZZ for NAV, though no hard number disclosed in their press release. Perhaps the company turns that down, as Earlston clearly sees more value beyond NAV?

    1. dt

      It keeps getting better by the day.

      The only additional upside to NAV would be the TZZ listing itself. If special committee decides to sell it would be the best outcome to shareholders as all final liquidation costs would be avoided.

      Earlston is merchant bank that specializes in providing real estate mortgages. So they could definitely find some use for TZZ listed vehicle to offload part of the exiting portfolio (if these are kept on bank’s books) or raise public funds for new mortgage portfolio.

      http://earlston.ca/recent-transactions/

  5. YVRtrader

    I’d be interested to see your analysis of TZS. Same wind up situation, but way below NAV due to a problematic loan. Much of what remains is in cash already.

  6. Michael Lax

    TZS.TO is trading at 2.47, TZZ.TO at 2.91, is this differrent companies or shares classes?

    1. dt

      It’s different companies managed by the same Manager. Both in liquidation mode and as of today both covered on the site. TZZ liquidation has played out already and the one for TZS might take much longer.

  7. work 22

    Any more thoughts on this TZZ? Haven’t heard much from FrontFour or Earlston– could they still be looking to buy out at NAV?

  8. dt

    Q3 results have been released. Surprisingly there is no update whatsoever regarding any of the two take-out proposals.

    NAV per share stands at C$0.64.

    G&A expenses have been somewhat higher during the quarter and I would expect these to drift lower going forward.

    1. work 22

      thanks. I see the $5 million mortgage left, but couldn’t find the amount of cash left on the books? Where did you see it? thanks! No update could mean no deal obviously, or the companies might have been waiting to see the latest numbers. Hopefully the latter…

        1. work 22

          thanks- duh. i thought cash number would be in the MD&A, hadn’t checked the interims. (duh lol!)

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