Street Capital Group, Inc. (OTCPK:CXSNF) Q2 2017 Earnings Conference Call August 3, 2017 7:30 AM ET
Welcome to Street Capital Group's Second Quarter 2017 Financial Results Conference Call. [Operator Instructions].
I would now turn the call over to Jonathan Ross, Head of Investor Relations for Street Capital Group. Please go ahead, Mr. Ross.
Thanks, Christa. Good morning, everyone, and thanks for joining us today. I'm joined on the call today by Ed Gettings, Chief Executive Officer of Street Capital; and Marissa Lauder, Chief Financial Officer. Street Capital Group's second quarter 2017 financial results were released today. The press release, financial statements, and MD&A are available on SEDAR, as well as on our website.
Before passing the call over to management, we would like to remind listeners that portions of today's discussion contain forward-looking statements that are based on management's exercise of business judgment, as well as assumptions made by and information currently available to management. When used in this conference call, the words may, plan, will, anticipate, believe, estimate, expect, intend and words of similar import are intended to identify any forward-looking statements. You should not place undue reliance on these forward-looking statements. These statements reflect our current view of future events, and are subject to certain risks and uncertainties as outlined in the Company's annual information form and other filings made with the securities regulators, which are available on SEDAR, www.sedar.com.
These factors include, without limitation, expansion opportunities, technological changes, regulatory changes and requirements including mortgage insurance rules, and changes to the business and economic environment, including but not limited to, Canadian Housing market conditions and activity, interest rates mortgage backed securities markets and employment conditions that may impact the Company, its mortgage origination volumes, launch of new products at planned times, investments and capital expenditures, and competitive factors that may impact revenue and operating costs.
Any of these factors, amongst others, could cause actual results to vary materially from current results or from the Company's currently anticipated future results and financial condition. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. We undertake no obligation, and do not intend, to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of any unanticipated events. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize.
I will now pass the call over to Ed Gettings, Chief Executive Officer of Street Capital Group.
John, thank you. Good morning everyone and thank you for participating on today's early morning call. I will make some opening remarks and pass the call to Marissa for some additional comments and then I will make some closing remarks before I open it up for question. Q2 2017 was a challenging quarter, we faced a number of short term hurdles in a market environment that has changed significantly year over year. Q2 was also an exciting period for Street Capital, as we successfully began to execute on our plan to enter the growing uninsured mortgage market with a launch of our Street Solutions Program to a small pilot group of brokers. During the quarter we originated $10.2 million in Street Solution Mortgages. We recently significantly expanded the distribution base and our track to originate the $150 million to $200 million that we have outlined to shareholders for the full year. Demand for this product is strong and we thank our valued mortgage broker partners for their support during the launch.
As projected we started to see significant benefit from our prime renewals during the Q2, with renewals up roughly 22% from Q2 last year. Renewals can be more than two times profitable the new originations and we expect them to be a significant contributor to our earnings profile over the next three years. However along with our industry peers we continue to face pressure on the prime side of our business due to the mortgage insurance rules introduced by the Department of Finance last year. As a result prime originations were down approximately 30% year over year in Q2 and we expect them to be 20% to 30% lower for the full year.
Our goal on an annual basis is to maintain a number four market share position in the broker channel, market share data was not available for Q2 at the time of this call but we're happy to update you upon request when it becomes available. We are pleased that total net gain of sale rates improved to 80 basis points this quarter compared to 71 basis points last quarter There were few offsetting factors contributing to the improvement but generally we experienced an improvement in our premium turns and we're successful in lowering our servicing costs for a proportion of our mortgages which lead to an increase in our deferred gain of sale that will be reoccurring.
Marissa will provide further commentary on that later on the call. So as I've outlined in the last quarterly call we are actively pursuing additional funding for prime uninsured mortgage loans with our industry leading credit quality and we believe that we are in a very strong position to attract it. As part of this process we continue to investigate the market for non-government sponsored residential mortgage backed securities as well we are in discussions with investors who are willing to purchase prime uninsurable mortgages and hold them on their balance sheets.
While we have made good progress on these fronts in the quarter, the timing and availability of these funding sources are still uncertain as is the ultimate profitability of this product. So well that does not reflect a restart of this business this year. As you know credit quality has always been our primary focus at Street Capital. This dedication to underwriting quality will continue to be our focus as we grow in the uninsured segment of the market. Today we did average LTV on Street Solutions originations is just under 72% and the average Beacon score is at very 703. As we have discussed we conduct a significant level of quality assurance of the loans we underwrite and the results of this additional diligence are apparent in our credit performance. Our serious arrears rate for a prime portfolio continues to significantly outperform the industry. In Q2 our serious arrears rate was 11 basis points compared to the average of the large Canadian banks in the markets where we operate at 24 basis points. This purpose [indiscernible] translates into our funding model on the uninsured side. We are funding these loans of fixed term GIC that are cash flow duration match with the underlying mortgage loans. We are managing our liquidity conservatively, can show that we are set up for stability and growth.
During Q2 we initiated an organization, and involved a reduction of approximately 10% for workforce. Management undertook a review of our cost base and current skill set with an understanding for current mortgage volumes and the future direction of the Street in the financial services industry. We identified some positions that could be eliminated and some areas where new skills will be required over the mid-term. The change reflects our commitment to continuously evaluate our needs to ensure we're driving long term returns for shareholders.
The headwinds facing Street Capital and [indiscernible] are apparent and well-publicized. I would like to strongly reiterated that we view these challenges as transient for Street Capital. As a schedule on bank with a solid balance sheet and diversified funding base we're well positioned to capitalize on the opportunities generated by market turbulence and to grow and generate shareholder returns over the long term.
I'll now turn the call over to Marissa for some additional commentary.
Thanks, Ed and good morning everyone. I'm pleased to % the Q2 financial highlights. Adjusted diluted earnings per share in Q2 were $0.02 compared to $0.05 last year and zero last quarter. Adjusted net income was 1.8 million for the quarter, net income has been adjusted for the reorganization expenses of $1.8 million after tax. New prime originations were $1.5 billion in the quarter and as expected this was 30% behind the same quarter last year.
Year-to-date we have originated 2.7 billion which is 19% below the first six months of 2016, and as Ed mentioned and discussed last quarter our originations have been negatively impacted by the changes in mortgage insurance rules last fall. Having said that given the mortgage products we do offer and do have available and the market environment we are pleased with the level of originations for the products that we do offer. As expected our renewal volumes have begun to accelerate and prime renewals move significantly higher drinking Q2, renewals volumes were 463 million up 52% over last quarter and 22% over last year. Renewal rates for the quarter came in at a bit below target of 72% versus the 75% to 80% target that we have. There are a few factors that have contributed to the low renewal rate renewal rate versus target. First, renewal rates tend to be lower in Q2 and Q3 with busier housing market.
Our year-to-date renewal rate is about 75%. Secondly, given the changes in the mortgage insurance role there has been some addition rate discounting in the market as lenders compete for highly sought after insured mortgages Additionally, there are some clients who request to refinance at renewal and since we are not able to offer this product right now given the changes to the mortgage insurance rules sometimes we cannot retain the customer. As Ed mentioned we are working hard behind funding solutions for the product and have make good progress on this in the quarter.
We also have several retention initiatives underway and despite the headwinds we are facing we will continue to target a renewal rate of 75% to 80% and as we have discussed before we expect to renewal volumes to increase meaningfully over 2016 in Q3 and Q4 and its 2018 and 2019. In the quarter we introduced more granular information on our gain on sale rates by splitting new sale information from renewal sale information in order to help our stakeholders better understand the drivers of revenue. So my discussion today is split between new and renewal gain on sales. For prime mortgage sales growth, growth gain on sale rates were 203 basis point significantly higher than last year's level of 188 basis points and up from a 184 basis points last quarter. The increase reflects some improvement in premiums we earned along with deferred gains and increase in deferred gains due to our reduction and our cost to service some mortgages. Additionally we had a promotion with an investor where they compensated us with higher premium for broker commission promotions. You will see the offset of this additional premium is in the related acquisition expenses. The acquisition expense ratio of 141 basis points was up from 124 basis points last year and up from a 130 basis points last quarter the increase primarily reflects a broker commission promotion that I mentioned.
For renewals the growth gain on sale rate was a 149 basis points compared to 163 basis points last year and 151 basis points last quarter. Renewal gain on sale premiums tend to be lower than new loans due to among other things discounting, a rate discounting for retention efforts, the product mix and also there are no additional premiums for brokerage commission promotions.
Acquisition expenses to renewals were 10 basis points consistent with prior period and include renewal fees paid to servicers and some trailer commissions associated with the discontinued loyalty program. As Ed mentioned we originated 10.2 million in Street Solution mortgages in the quarter. These are funded with a portfolio of fixed term GIC and the average rate on the Street Solution mortgages was 5.0%. In the quarter we began to build the balance sheet and accumulate our liquidity pool and as such interest expense exceeded interest income from lending assets and we generated a net loss of 200,000 on non-securitized lending assets. The gross spread between Street Solution mortgages and the deposits in the quarter has been in a range such that we still expect Street Solutions to earn a net interest margin of between 2% and 2.5% once the mortgage assets are more in-line with the funding base. We are managing our funding and liquidity conservatively, we are not offering demand or hit [ph] the deposit products and we're actively issuing GICs across all terms. At June 30, our deposit base was 72 million and our liquid assets was 49 million. The term mix of the deposits at quarter end was 23% one year GIC, 36% two year, 17% three year, 5% four year and 14% five year. Interest rates from these deposits range from 1% to 2.8% with the average being 2.2% to the extent that GIC rates have been higher in the segment with recent market events we anticipated being able to pass these costs on through higher mortgage rates and this expectation was proven out during Q2.
Street Capital Bank CET1 ratio at the end of Q2 was 29.99% and its leverage ratio was 18.37% which both are well above regulatory minimum in our internal target. As we continue to grow our balance sheet we expect this ratio to trend into more optimized range with a corresponding lift to return on equity. Operating expenses excluding restructuring charges of 2.5 million before tax were 13.7 million up from 10.7 million last quarter and 12.1 million last year. Salaries and benefits increased 2 million quarter over quarter and 600,000 over last year.
The increase quarter over quarter reflects higher variable compensation while the increase compared to Q2 last year reflects both quarter at a higher headcount level. As Ed mentioned we implemented a reorganization plan in late Q2 that among other items result in the reduction of our workforce by about 10%. Reorganization costs of 2.5 million pretax were booked in the quarter related to these activities. On an ongoing basis in the short to mid-term the workforce reduction will result in savings of about $1.5 million to $2 million annually. As the company moves forward and continues to develop its strategy we would expect that additional skills and talent will be brought on board in the midterm. However we are still targeting to achieve a positive operating leverage starting in 2018.
Recently OSFI announced proposed changes to guidelines in B20. While main principles remain intact there are a number of potential new and enhanced requirements. At Street we're continuing to review the potential implications of these changes and are preparing our comments for OSFI.
While we cannot be certain of the effects of these changes, it could have we believe if implemented with no changes there could be an overall decline in uninsured mortgage activity in the regulated space. Along with buyers adapting their borrowing habits for example perhaps choosing less expensive properties or accumulating larger down payments or adding co-signers to the loan, for us as we have communicated we have fairly modest uninsured mortgage origination target and especially when compared to size of the market overall. And right now we believe we can meet these target even if the changes to be B20 are implemented. In that regard we have not changed the guidance and targets for uninsured origination that we issued.
Now before I pass the call back to Ed I would like to say a few words. I've the pleasure and the benefit of working with Ed over the last two years and as Ed retires as CEO at the end of the month I want to take this chance to thank Ed for his support and his mentorship over the last two years and I'm quite pleased that Ed will remain on the board to continue to provide his insights. Ed along with Lazaro and Paul have built a solid foundation of mortgage lending business that is quite a force in the market and this was nothing 10 years ago. I'm proud to say I work at the company that they have built and I'm not also thrilled and privileged to be part of the next stage of building this bank with the Street Capital team. So with that thank you Ed. The call is yours.
Thank you, Marissa. As we announced in June 29 Duncan Hannay will be joining Street Capital's President and CEO starting September 1st along with the rest of the Board of Directors and a management team I am excited to welcome him to the Street Capital team. Duncan is joining at a critical juncture as we begin to grow in diversified Street Capital Bank. He has significant experience building innovative, customer centric financial services business and his knowledge and leadership will empower our team has [indiscernible] solutions and will better serve our customers and valued mortgage broker partners in the coming years.
Duncan is the right leader to take this company to the next level as a strong, diversified player in the Canadian banking sector and I am looking forward to what is in store over the next 10 years. As part of this transition I will retire CEO of Street Capital on September 1st but will remain as the Director in the Board. So in closing I would like to thank the members of the board, the members of our management team and each employee of Street Capital for their support and contribution in building this terrific business to where it is today. I'm very proud of what our team has accomplished over the past 10 years.
Street Capital is at an competitive, advantageous position and this would not have been possible without the efforts of each and every one of those individuals. I would also like to thank our long term shareholders. We have a strong shareholder base and it's truly been a pleasure to interact with each of you as we built Street Capital where it is today. And I say with absolute certainty that for Street Capital the best is yet to come.
I would now like to open the line for questions.
[Operator Instructions]. Your first question comes from the line of Dylan Steuart with Industrial Alliance Solutions. Your line is now open.
Quick question on the restructuring you announced, just wondering about as this quarter the 2.5 million, is this going to be the end of it going forward or should we expect more charges flowing through the next couple of quarters here?
If there is further charges they won't be material like that, there could be small adjustments to that number but I'm not expecting them to be material. So that's it for the year.
Okay, perfect. And I guess you might have provided this, I might have missed it but just the, I guess the focus of the restructuring as far as staffing where were the areas hit I guess?
It was across the organization. Obviously when you look at our headcount we had quite a lot of people in the underwriting group. So there is a higher proportion of people in the underwriting group that we felt we didn't need those roles and that reflects the level of originations that we're doing this year, but there was a look across the entire organization so every particular department had some type of reduction except for our controlled functions.
Okay, perfect. And I guess just on the margins I appreciate the color in the quarter. Just I know some of your competitors were sort of hinting that the broker compensation might be going up squeezing margins a bit but it sounds like from what I can tell you guys margin levels it's been fairly steady in the near term is that fair to say?
Well we're hoping that they are fairly study in the near term, we're seeing that right now as I've said for many quarters the market can be quite volatile and there is a lot of competition in the marketplace for insured mortgages and sometimes that results in lower mortgage rates that sometimes will affect our spread. So it looks okay right now Dillon but I can't tell what's happening in the future right now.
Okay. And then just finally just on the funding for the prime uninsured, just reading between the lines, it sounds like things are a lot closer to finding a solution to that than even three months ago in the last quarter.
We have been aggressively working to find solutions to that prime uninsured liquidity gap that we and other of our competitors have in the marketplace and we're feeling good about finding a solution for that gap that we've got right now and once we have that I think we will be, well I don't think we will be in a very, very competitive position with a full suite of prime insured, uninsured as well as the true uninsured Street Solutions product that we have in the market now.
Your next question comes from the line of Brenna Phelan with Raymond James. Your line is now open.
Can you just talk a little bit about the volumes that you've seen in the non-prime space subsequent to the quarter? Has there been any impact of people get spoked like are you seeing a bit of surge?
I've to clarify our terminology here. So there is prime uninsured, and then there is the new program.
Sorry, non-prime, you always correct me on that. Non-prime.
We're very happy with what we have seen so far. We purposely limited the roll out to a small group of brokers I think it was started with 30 then it went up to 70. We were focused on Ontario. We wanted to test and learn in terms of lending areas, what the pricing is, what the credit quality was going to be and we have recently expanded to all of our brokers in Ontario and select brokers in Alberta and DC and we have gone from I will say 2 million a week in commitments to over 20 right now. So we're very happy with that, there's a lots of demand for that product. The brokers are enthusiastic about another lender being in the marketplace so we have no concerns whatsoever about hitting our targets for this or for next year.
Okay, you said 2 million in commitment a week to 20 million in commitments per week?
20 million plus a week right. Brenna, one thing I'll point out to you we've got an extensive distribution base right now so it's as I said early on it was going to be us limiting the distribution to hit our targets and so we've opened it up but we're just turning on the existing distribution base that we have right now so it's been very well received.
Okay. And then just in one of your financial statement notes a breakdown of total non-securitized loans there are some bridge loans, can you - what are those?
Those are bridge loans where customer has needs some short term financing. We have actually, I forgot whether I'm going to get this right they've sold their home and they need up the equity in their home for their experts [ph] and it's usually anywhere between a week to 45 days for any of the short term loan. So those are transitory items on our balance sheet. I think it's a simple short term consumer loan that's secured against the property.
If there are customers because we're expecting the mortgage on their new property. So we're allowing them to bridge the difference between the closing dates.
Is that something that we should expect to continue?
Well we've had it for a long time, eight years and we've just never broken it out before but it's always around that volume of business that you're seeing right there. We've never lost any money on this business, it's a good solid business the customer wants to mortgage from us on the other side and we have in a lot of cases the collateral against the property that's selling. So it's a good service.
Yes and it looks yieldly too?
It's not a payday loan but it's a good yield.
Okay, and then just with respect to the workforce reduction. How does that - so you have new underwriters coming on for the non-prime function and then just some calling of some staff just for volumes in the prime, the prime insured function.
That's a good way to frame it. The fact that we are forecasting at this point a 20% to 30% reduction in the prime insured or uninsurable segment that we just right size and reorganized.
Okay, and was there any one that moved over from prime underwriting to non-prime underwriting or were those mostly new hires?
No I believe - I actually don't know the specific answer to that but I believe that we did transfer some people from the prime side to the uninsured because we had about four years ago we did have an uninsured program so they moved over - those underwriters moved over the prime side, we transferred some of them back and then also wrote I believe that we brought on some new hires but that team is pretty small at this point, it's only located. We have one underwriter in the Vancouver office and the rest of them are in the Toronto office.
Your next question comes from the line of Jeff Fenwick with Cormark Securities. Your line is now open.
Just wanted to follow-up on the renewal volumes you're seeing, and some commentary on the pressure that you're seeing there in terms of your ability to hit your target of that 75% to 80% range. I mean it sounds like some of the loans are getting excluded now in terms of your ability to renew them and some comments on competition here too. So what gives you confidence that you're going to be able to recover from that level and get back up to where you want to be?
So the quarter typically the Q2 quarter is a lower retention level Jeff. Year-to-date we're just slightly under the 75% to 80% target that we have hit and we are doing a number of initiatives internally to work to ensure that we do hit the 75% to 80% target level. The product area that I think not just Street Capital but other companies will find challenging is the fact that if you do not have the prime uninsurable product it essentially eliminates you from being able to offer customers who want to refinance at renewal, in other words they want to add additional money to the mortgage loan. We don't have the liquidity for that at this point but we are working on getting that liquidity.
Okay. And I guess that was my concern there is that you'd be at a disadvantage maybe to the larger banks on that front and we will lose a certain proportion of that volume. And it sounds like some of these customers when you can't keep them are obviously they are valuable to have and there's some mention there of competition on pricing as well and if you like that would it normalize as we go forward from here?
Well typically a renewing customer is more price sensitive because they are not --they've already been approved they know they can get approved for renewal. So we typically find that renewing customers are more price competitive and might negotiate more often and so we have - we're willing to do that because we're not paying the same level of acquisition cost as the new loan.
[Operator Instructions]. Your next question comes from the line of Jaeme Gloyn with National Bank Financial. Your line is now open.
So I just want to clarify the employee headcount, you mentioned it's right sized meaning its more from [indiscernible] and we're expecting too much in 2017. If competition competitive environment remains the way it is today how does the employee headcount look in 2018, I guess is there a potential for more rationalization here in '18 either on headcount or premises or other expense line items?
In terms of the FPE [ph] amounts that we're seeing here, I hope not. I hope that and I believe the company will continue to grow and I actually believe our headcount will start to go up and I've indicated that in terms of as we develop our strategy and we think to the future, we will be adding people with perhaps different skill sets particularly on the digital and marketing side, I think that's an important strategy that will go forward with. So I'm thinking that over time the headcount will go up but like I said I think the most important thing is from an operating leverage perspective we still are targeting in 2018 for that to be positive.
From other operational expense perspectives we're always rationalizing our operating expenses. We are planning to close our one trial Street office in 2018 and have everybody at our one young Street office that will save us a little bit of money but because of the terms of the lease they're really just subletting that space so it won't be huge savings. And I think like I said Jaeme the thing that's more important I think is that we will be expecting positive operating leverage in 2018.
And I apologize if this was addressed in the initial remarks but I just want to clarify the promotion for the investors so on the gain on sale, the gross gain on sale margin that drove that higher and I guess on the other side the promotions with broker commissions. Did any of these extend into Q3 and what is your view of maintaining similar promotions to drive origination growth on both sides of the funding and on the origination side?
Jaeme, that's a difficult question to answer because I don't know what our competition is going to be, so we will react to the competition. I just say as a philosophy we don't believe that we need to have the highest compensation in the marketplace. We actually value product and service as the key differentiators for us. So I really can't give you specific answer and that one is going to vary quarter by quarter.
Okay, are any of these promotions still in place today or is it do we go back to sort of a Q2, sorry Q1 sort of run rate on gain on sale or net gain on sale at the end of the day?
So Jaeme they are not in place today that doesn't mean as I've said they won't get added later in the quarter or later this year, but I think the thing to remember there is it's grossed up on both sides so it's actually on a net basis, a little bit negative to the next gain on sale rate because we're not quite recovering all of the promotional commissions from our investors.
Okay. Next question just related to previous question on the commitments in the non or the near prime uninsured mortgage space running at about 20 million a week, I mean that only takes 10 weeks to hit your target. So what is the book to bill rate on commitments well that's question one, question two, is what you see in terms of mortgage rate impact? We hear other broker or other lenders talking about 50 to 150 basis points of increases after the home capital liquidity crisis? What are you seeing on rates and how is that different from your initial expectations going into this uninsured space?
So let me break that down Jaeme, first of all remember commitment is not equal to the funded loan so there is some drop off to it but at a 20 million per week commitment level, we're on target to hit our $150 million to $200 million origination volume that we stated so we're on target to hit that at that level.
Secondly, in terms of rates yes it's been higher rates on the deposit side so we're paying more to earn that liquidity but we are seeing that that is being passed on to the marketplace for the customer as well. So the margin target of 2% to 2.5% that we stated is still intact on the Street Solutions uninsured product.
Okay. And just in terms of versus your base expectations prior to entering the market after the home caps what would have been the difference pre-home cap liquidity crisis to today for example?
The biggest change is the cost of deposit has gone up and we have been successfully able to pass that on to the customer so the margins have been maintained but it's really - you can look at the GIC boards you see that Home Capital, or Home Bank are premium priced in the marketplace to attract the liquidity. We have not been premium price, we have not been matching them and we have been able to attract sufficient deposit liquidity to meet our demand on the mortgage side.
Okay. And just on that mortgage growth rate side, is there any potential that you go above the 200 million guidance for 2017 just given the level of commitments you're receiving at this point?
Jaeme, at this point we are a target for our commitment that we have - the 200 million that we talked about and again as I said earlier in the call we are quite happy with the demand that we got for the product and the support that we've got from our broker partners.
And there are no further questions at this time. I'll turn the call back over to Jon.
Thank you room, it is fitting today, let us know if you have any further questions throughout the day, reach out to us and we're happy to answer them. Thanks again.
And this concludes today's conference call. You may now disconnect.
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