Street Capital Group's (CXSNF) CEO Ed Gettings on Q2 2016 Results - Earnings Call Transcript

| About: Street Capital (CXSNF)

Street Capital Group Incorporated (OTCPK:CXSNF) Q2 2016 Earnings Conference Call August 10, 2016 9:00 AM ET

Executives

Jonathan Ross - Head, IR

Ed Gettings - CEO

Marissa Lauder - CFO

Lazaro DaRocha - President

Analysts

Dylan Steuart - Industrial Alliance Securities

Jaeme Gloyn - National Bank Financial

Jeff Fenwick - Cormark Securities

Marc Charbin - Laurentian Bank Securities

Operator

Hi, everyone. Welcome to Street Capital Group's Second Quarter 2016 Financial Results Conference Call. As a reminder, this conference is being recorded on Wednesday, August 10, 2016. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for research analysts to queue up for questions. [Operator Instructions]

I will now turn the call over to Jonathan Ross, Head of Investor Relations for Street Capital Group. Please go ahead Mr. Ross.

Jonathan Ross

Thanks, Sharon. Good morning, everyone, and thanks for joining us today. Street Capital Group's second quarter 2016 financial results were released today. The press release, financial statements, and MD&A are available on SEDAR, as well as on our Web site, streetcapitalgroup.ca. Before passing the call over to Ed Gettings, we would like to remind listeners that portions of today's discussions contain forward-looking statements that reflect current views with respect to future events, such as Street Capital Group’s outlook for future performance. Any such statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are implied in making forward-looking statements, and actual results may differ materially from those expressed or implied in such statements.

Factors that could cause actual results or events to differ materially from current expectations include, among other things, risks related to market factors, no assurance that Street Capital will receive regulatory approvals to operate as a Schedule I bank, and other factors discussed in materials filed with applicable securities regulatory authorities from time-to-time, including matters discussed under Risk Factors in the Company's Annual Information Form for the year ended December 31, 2015. Street Capital Group does not undertake to update any forward-looking statements, except as required.

I will now pass the call over to Ed Gettings, Chief Executive Officer of Street Capital Group.

Ed Gettings

Thank you, Jon. Good morning, everyone, and thank you for participating on today’s call. I am joined on the call today by Lazaro DaRocha, President of Street Capital; and Marissa Lauder, our Chief Financial Officer. We are very optimistic regarding the future of Street Capital Group. Management has heavily invested in the future of the Company owning almost 20% of the outstanding stock and is very focused on creating shareholder value. Since we initiated our normal course issuer bid in March, we have been active in the market and till July 31st have repurchased 327,106 common shares. We will continue to be active in the market at these prices.

This year we are focused on putting the pieces in place to drive revenue growth starting in 2017. We have three primary objectives in 2016. Our first objective is to advance our Schedule I bank application through to completion. The bank platform allows transaction from a single product vendor to a multi-channel, multi-product financial services entity. We continue to advance this application during the quarter and Lazaro will update you later on in the call with more details.

Our second objective is to grow mortgages under administration and hold our market share in the mortgage broker channel. Originations were lower than what we would have liked during the quarter, as the underwriting adjustments we made in Q1 2016 had some spillover effects in the second quarter of 2016. Mortgage commitments issued in Q1 2016 for closing in Q2 2016 were lower and effective Q2 new originations. However, in the latter part of the quarter, we were back on track and our market position in the broker channel reflects this as we improved to fourth position from sixth last quarter. We are looking forward to a continual recovery during the second half of the year and are targeting to remain number 3 or 4 in the broker channel.

We expect Q3 and Q4 2016 to be stronger than the comparable periods in 2015, however the disruption caused by the underwriting changes we implemented back in Q1 will cause earnings to be lower this year than we had originally expected. Our third objective for 2016 is to continue to generate renewal volumes of 75 to 80% of loans eligible for renewal. Year-to-date, we have renewed $710 million of mortgages which is close to the 75% of those available for renewal. Moving into next year in 2018, we will drive solid earnings growth as loans underwritten in the past years come up for renewal.

We have built a substantial brand in the industry. With our 130,000 customers and key broker relationships as a base, we see a bank platform as the optimal foundation to leverage our leading brand into a multi-product multi-channel opportunity. And we are looking forward to using this program, this platform to drive significant value for our shareholders in the coming years.

I’ll now turn the call over to Marissa for some additional commentary.

Marissa Lauder

Thank you, Ed and good morning everyone. I am pleased to present the second quarter 2016 key financial highlights. Adjusted earnings per share were $0.05 in the quarter compared to $0.09 last year, while we did anticipate lower EPS per share given our expectations for lower renewal volumes and higher expenses, new origination were below our targets for the quarter for the reasons Ed already described.

We sold 2.54 billion of mortgages in Q2 compared to 3 billion last year. Of this total, 380 million were renewals compared to 407 million last year. Net gains on sales mortgages were 19.8 million compared to 26.2 last year. Gains as a percentage of mortgages sold was 185 basis points in the quarter, above our normally expected range of 178 to 182 basis points. This was lower than the 190 basis points in Q2 2015 when spreads were higher than normal.

We continue to expect that on a full year basis, gains as a percentage of months sold will be in the range of 178 to 182 basis points. Our acquisition expense ratio was 106 basis points in the quarter, this compares to 102 basis points last year. The increase reflects lower relative renewal volume year-over-year and a broker incentive program we launched late in Q1 2016 that increased the acquisition cost in the quarter.

Moving into the remainder of the year, we continue to expect 2016 renewal volumes that are approximately 15% lower compared to the 101.7 billion renewed in 2015. But in 2017, as we’ve discussed previously, we expect the upper trend in renewal volumes to resume. With renewal volumes expected to exceed to 2015 renewal volumes by 10% to 15% and 2018 renewal volumes are expected to increase by 30% to 40% over a strong 2017 providing a real revenue boost in these years.

While expenses were managed tightly in the quarter, as anticipated they were up sequentially from Q1. This reflects the growth in our people from 187 to 241 year-over-year and from 215 in Q1 2016. As we continue to advance our Schedule I bank application, this also reflects staff additions to support the operational changes that we made in Q1 and into Q2. Given our current primary business model of originate to sell we measure our expenses efficiency by the ratio of operating expenses as a percent of mortgages originated and herniated.

In Q2 2016, this ratio was 48 basis points and as expected this is up from 37 basis points last year. Given the seasonal nature of mortgage originations and renewals, this measure will vary by quarter. On a 12 month basis, we expect this ratio to be in the range of 46 to 52 basis points through to 2018 with 2016 coming in at the high-end of this range.

Before I close, I’d also like to draw your attention to our tax loss carry forward balance which was 315 million at the end of June. This represents a real and sustainable advantage for the Company. For us this means that right now we’re not paying any cash taxes and we don’t expect to pay cash taxes for many years to come. As a result, the net income after tax measure underestimates the true earnings available to the Company.

With that, I’ll pass the call to Lazaro.

Lazaro DaRocha

Thanks Marissa. Good morning. As you know at Street Capital we are focused on credit quality as our number one priority. Our credit quality continues to be strong. At June 30th, the serious arrears rate on our portfolio of mortgages was 11 basis points well below the CBA performance. This is also well below last year which had 16 basis points was also a very good rate on a well seasoned portfolio. At the end of June, at time of origination, the average beacon score on our portfolio was 749, the average loan to value ratio was 81.2% and the average total debt service ratio was 36.1%.

Now turning to the status of our bank application. As you know, we are in the pre-commencement review phase of our application to the Minister of Finance to continue as a Schedule I bank. As discussed last quarter, in Q1 the Company implemented various operational changes in order to address the observations from their onsite review in Q4 of 2015. In Q1, we informed you that we expected OSFI to return onsite during this summer to confirm that the changes made by the Company have been adequately implemented.

We are pleased to confirm that OSFI did in fact return in July and we are now awaiting the results of that visit. We continue to fully expect to receive approvals to operate as Schedule I bank in fiscal 2016. However, we have not built any meaningful contribution of profitability into our expectations until 2017. At this point, I’d like to ask the operator to open the lines for questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Dylan Steuart from Industrial Alliance. Your line is open.

Dylan Steuart

A quick question, you guys reiterated your view that new originations for 2016 should match 2015 obviously the first half a little bit late so. And just maybe a bit more color and what you’re seeing out there that gives you the confidence in that outlook?

Ed Gettings

Dylan we’re looking at our current pipeline and we’re feeling good about the fact that we think we have turned the corner on those operational issues that we’re dealing with in Q1 and Q2. Market share during the quarter went up as well from 7.6 in Q1 to 8.4% placing us in number four position. So we believe that we are building momentum and we’re clearly headed in the right direction.

Dylan Steuart

All right, just looking at the market [Multiple Speakers], sorry go ahead.

Marissa Lauder

Sorry Dylan. Also compared to 2015, we expect the second half of this year to be stronger than 2015.

Dylan Steuart

Okay. And I guess maybe just a general market commentary given the affordability issues in Toronto Vancouver. Are you seeing any less demand from first timers that are being squeezed out of the market, are you still seeing I guess the healthy pipeline overall?

Ed Gettings

What I read in industry reports Dylan is that we still have a very healthy pipeline. The broker channel itself is growing at about between 4% and 5% year-over-year on a year-to-date basis. First time buyers, yes the price points are being stretched for them and what I understand is happening is that instead of buying houses, they are focusing on condominiums because the price point is more attractive for them.

Dylan Steuart

Okay. And just one final question, just on the new bodies added I believe it went up to 241 from 215 last quarter, just wondering what area of hires that you made on the increased body count?

Ed Gettings

They were primarily if not all within our underwriting and QA areas, they are all in response to the actions we took given OSFI’s visit back in Q4 of last year.

Dylan Steuart

Okay. That’s sort of what I figured and you remain pretty confident at these staffing levels or will there be any more expansion required, do you think in the near-future here?

Ed Gettings

I don’t envision having any sort of material expansion for any of the significant operational changes. I think that’s behind us. Any increases would be nominal at this point.

Operator

Your next question comes from Jaeme Gloyn from National Bank Financial. Your line is open.

Jaeme Gloyn

I was just hoping that you could provide a little more color on the broker incentive program and some details around that and how much of a contribution was that to the increase in acquisition costs?

Marissa Lauder

Hello Jaeme, thank you for the question. We had a broker incentive program out there that basically increased the acquisition costs on a net basis by about 5 basis points on certain products. And so given that the contributions is anywhere between 3 and 4 basis points on the acquisition cost. That program was discontinued however there are some mortgages in the pipeline that will come through in the third quarter with that promo on it.

Jaeme Gloyn

Okay, so some in Q3, but Q4 we shouldn’t expect to see anything from [Multiple Speakers]?

Marissa Lauder

Well we react to competitive nature of commissions. So I can’t say we wouldn’t introduce another promo.

Jaeme Gloyn

Okay. And this was just sort of like a one-time quick promo that you can turn on and off anytime?

Ed Gettings

Yes, and Marissa alluded to the fact that was a reaction by what was in the market by our competitors. So, that’s what she means by it. We always need to be competitive, we’re never the lowest rate or the highest commission but we need to be competitive. So this was a reaction to others’ moves.

Jaeme Gloyn

And just talking about the 2018 renewal pipeline that’s going to -- your expectation that is going to increase 30% to 40% over 2017 renewals, what’s driving that number and I am trying to base this off of a origination growth in 2013 versus 2012 of 30%, so it's kind of like one for one whereas in 2017 we’re not getting that one for one versus the origination year. So, if you could just provide a little more color on that 30 to 40?

Marissa Lauder

Okay. I’ll have to look into the numbers in a little more detail, but generally speaking the 2017 number still have some spillover effects from the three to four year promos that we had talked about that reduced the 2016 renewals. So it's the mix of the book.

Jaeme Gloyn

Okay.

Marissa Lauder

Whereas the mortgages coming up for renewal in 2018 were primarily five year.

Jaeme Gloyn

Okay. And how is the mix currently with respect to mortgage originated, is it back to primarily five year we say a sort of above the 90% bubble?

Ed Gettings

Yes we’re typically originating five year terms Jaeme as a rule of thumb but from time to time there might be some promotions. But our pattern exceptionally led at the five year cycle.

Jaeme Gloyn

And then just last one for me, in Alberta can you provide a little more color around the performance originations, is it decline of X percent year-over-year, what you’re seeing in that market specifically?

Ed Gettings

It's a slight decline on year-to-date originations. We would have had 15% of the book in Alberta last year it's dropped down to 14%. So it's definitely a function of the market in Alberta as well as some of our underwriting guidelines.

Operator

Your next question comes from Jeff Fenwick from Cormark Securities. Your line is open.

Jeff Fenwick

Just wanted to follow-up on the questions around renewals, you mentioned in your opening comments that you’re approaching 75% of renewals and you hope to achieve that number or higher going forward. So, can you just give us some color around what allows you to get there or enables you to get there, is it a question of customer service or data analytics or some combination of factors such as that?

Ed Gettings

Yes it is our target range of 75% to 80% Jeff and we definitely have a retention team in place that if we see a customer calling in that has a desire like for tail statement or something like that we will immediately reflect them to our in house retention team and we’ll have a dialogue with the customer to understand what their needs are, if they’re looking to negotiate a bid on rate we’ll take that into account. But our goal is to product renew in the 75% to 80% range.

Jeff Fenwick

And are you proactively reaching in to customer centers or approaching in the term on the mortgage lender to make sure you do that?

Ed Gettings

We’re mailing out a standard renewal 90 days in advance if we haven’t heard from that customer within 30 days we are calling them and we are contacting them to open up a dialogue with them. Also what we are doing is also going out throughout the term of the mortgage with communications to our portfolio. And again the objective behind that communication strategy is just like to know that we are here if they have refinancing needs or other sort of financial needs that they can call Street directly and we’ll work with them to solve their issues.

Jeff Fenwick

Okay. And I noticed that in your MD&A you’ve provided us with a table here on the MUA maturities expected going forward. I am just wondering does that number factor in amortization off of those mortgages or prepayment patterns or should we just be looking at that number and taking 75% as your target?

Marissa Lauder

I wouldn’t take 75% as it, those are contractual maturities so they reflect the balance today and the contractual maturities that equal to that balance. And you would have to consider both mid-term liquidations, amortization and renewal rates.

Jeff Fenwick

Okay, that’s great. That what I was wondering. And then with respect to the bank, you do give us some sort of pro forma capital ratios that you would expect if you were to look at it or to become a bank today. Can you give us the -- an estimate what the gross value of the regulatory capital would be that you have on commencement of the bank. Is it effectively your shareholder’s equity today or what’s the adjustment there?

Ed Gettings

It would be what is disclosed on our Street Capital Financial Corporation legal entity shareholders’ equity which is different than the parent company’s shareholder equity.

Marissa Lauder

So the shareholders’ equity in the parent includes a higher amount of shareholders’ equity than would be in the sub we haven’t disclosed that yet unfortunately.

Ed Gettings

Okay, taking that off now I can tell you that OSFI is satisfied with the capital in the subsidiary that is going to become the bank.

Jeff Fenwick

Got you. Okay, and then maybe just one last question here, there was a question earlier about Alberta but I noticed a lot of your origination and growth here is going to be focusing on the BC market which is obviously very hot. Can you just give us some thoughts about how you’re approaching that market given how the prices have shot so much higher this year and all the concerns about that market?

Ed Gettings

So two things I want to remind everybody that 100% of our loans are ensured that doesn’t mean that we ignore the credit risk we operate as if we own it reflected in our 11 basis points of serious arrears but the other aspect is that we are really not targeting that high-end segment of the marketplace. So like other lenders we have a sliding scale, so as you go up in the loan amount we reduce the loan to value that we will lend to you as a customer and you have that more skin in the game. Two examples, if it is a million dollar home and you’re looking forward you have to put 20% down because it’s over $1 million. You have to put in $200 million and you might be looking to Street for $800,000. We might consider lending that full amount depending on a number of underwriting criteria. If it is a $3 million home you have to have $600,000 in as a down payment and you’re looking for 2.4, I am not, the maximum that I will lend is in the 18-19 range which takes our loan to value down to the 60% to 65% range. So we’ve got lots of capital protection and in the case of a default or a downturn in the marketplace. Our average loan size is in the $375,000 range.

Operator

[Operator Instructions] Your next question comes from Marc Charbin from Laurentian Bank Securities. Your line is open.

Marc Charbin

Just a quick question on your targeted expense ratio, does that also apply to the incremental revenue you’d expect from a successful bank application?

Marissa Lauder

Yes, it does. So the range of 46 to 52 applies on that as well.

Marc Charbin

Okay. And in terms of nominal expense growth looking at 2017, would you say it be above or below 8%?

Marissa Lauder

Well, as we move through our planning cycle this year and think about our strategy and growing the business and taking advantage of the banking platform. We’re going to balance our operating leverage improvement with the need to invest in the future. So, given the range, that’s the range that we expect to operate in to improve our profitability. But as we move through I can’t really give you guidance that is that specific.

Operator

[Operator Instructions] We do not have any questions at this time. I will turn the call over to the presenters.

Ed Gettings

Thanks everyone for participating on today’s call and for your support. Just feel free to reach out at any time today if you have any other questions. Thanks and talk to you next quarter. Bye.

Operator

This concludes today’s conference call and you may now disconnect.

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