Buy Atrium MIC – Update

Cymorfund Investment Letter stock picks  today highlights Atrium – (AI-TSX) an unknown small cap Mortgage Investment Corporation, known as a MIC.  (AI-TSX – $10.18)

Most people look to REITS (Real Estate Investment Trusts) to have a secure investment in the real estate sector that will also provide a reasonable income flow for the investment. There is another vehicle that provides mortgage financing to the real estate sector that has fewer competitors, can be a very secure investment, and usually outperforms REITS. These entities are called MICs and are either Investments Trusts or Investment Corporations. Because of restrictions in the law, those that are Trusts are converting to Corporations. 

Buy Atrium Mortgage Investment Corporation (AI-TSX) – $10.18

 

 

 What is a Mortgage Investment Corporation (MIC)

Under Canadian law, there is an entity that is treated like a Trust, but is in fact a corporation. The rules are quite simple actually.

• The majority of the funds of the corporation must be invested in real estate mortgages
• There is no income tax charged at the corporate level so long as 100% of the earnings each year is dividended out to the shareholders.
• Dividends received by shareholders are treated as if the income is interest income.

There are a few such entities listed on the TSX, and Atrium Investment Corporation (AI)  is a relatively new listing, having gone public 1 year ago (October 2012). It started trading around $12. jumped to $15, and then stabilized around the $11 mark. In June 2013, it dropped from $11 to just over $10 for no good reason.

What is the Upside of This Stock

Straight Income

The managers of this MIC are very conservative and their investments are very well secured. They currently pay a dividend of 8.74%, which is very attractive. There are few places one can rely on earning this type of return. But the return is much greater than 8.74%.

The 8.74% dividend represents the monthly dividend paid for each of 12 months a year. But remember that this is a MIC and must pay out all of its earnings each year. So there is a 13th dividend every year, and until the annual profit can be determined, the amount of this 13th dividend is unknown. 

Bottom line is that the return is greater than that estimated – probably closer to 9% per annum, although this is only an estimate. 

Capital Appreciation

If you did a survey of every interest bearing investment available to you, very few pay an annual interest rate this high. As this company gets more recognition, the stock price will likely rise as people need this type of income. Analysts from 4 different houses have an average  target price of $12.31. 

As today’s price is $10.18, this would be a gain of $2.13 or 21%.  Add the estimated dividends of 9%, and the real return is over 30%.

How Does AI Get Business and Why is the Return So Good?

This MIC is able to give mortgages out in special situations and therefore has great opportunities. The management is both very experienced in real estate, and has the ability to move quickly. Conventional sources take far longer to approve mortgage loans, so when there is an urgency, a much higher premium can be charged, making this MIC very profitable.

Conventional lenders have many criteria, especially in light of the 2008 meltdown. If every box in a mortgage application is not ticked properly, loans are easily denied, even when the lender is more than qualified. Being a lender with long experience, AI recognizes what is important and what is not. Once again, not being able to get a conventional mortgage easily, makes AI the alternative and a premium is always charged.

If a bank rejects a mortgage for any reason, even if the security is overwhelming, there are few alternatives aside from MICs. 

How Does AI Finance its Mortgage Lending?

Mostly through its own equity, but it did arrange a long term financing last year of $35 million at an annual interest rate of 5.25% for a 7 year fixed term. Lending this money at 8.7% is very profitable.  A small bank line is available to temporarily cover any quick needs for lending.

Most loans to borrowers are for 12 to 18 months, and the AI portfolio is estimated to turn over 50% every year. Having long term low cost borrowings at 5.25% matched with higher interest lending of shorter term is quite profitable and the risk of increasing interest rates is not a concern. If anything, it will create more profits.

Why is the Investment Secure?

•  Over 65% of lending is currently on residential real estate (minimum of 50%)
• The mortgage portfolio is high quality. 87% is in first mortgages and 95% of the lending is less than 75% of real value of the real estate. Compare this to other MICs who have much poorer loan to value ratios.
• Most MIC’s specialize in 2nd and 3rd mortgages, but this MIC does mostly 1st mortgages with no one ahead in priority.
• The Company has shown consistent growth each quarter. Earnings for the latest quarter are $0.22 per share.
• Because of the high quality of lending, defaults are rare, and losses are infrequent.
• Mortgage lending is restricted to major urban centers in Canada (91%).
• Management owns 8% of the shares and their earnings are directly related to MIC performance.
• Management charges are only 0.85% of assets annually, which is very modest with no performance fees, and no trailer fees. Management makes most money by the performance of the shares.

 Where is the RISK? 

There are risks associated with every investment, and no one can ever accurately predict the future. Maybe taxation rules will change, or management will fall apart or do something stupid. Maybe an error will be made and some investment will go horribly wrong with ensuing lawsuits and costs.

I think the real issues are that this is a very small company with only $270 million in assets.  If the market changes and the big boys re-enter a very competitive market, this company may find it hard to maintain its performance. This reminds me of looking for something to worry about, rather than a real worry.

This company is sort of an orphan in the market. It has very light trading volume and little interest from investors. If no one is interested in buying the stock, whether it is a good value of not, it may be hard to achieve a growth in share price, and it may be hard to sell the shares at a good price.

Lastly, because of its small size, many major investments funds are prevented from buying this stock, therefore reducing demand.

 

Buy Atrium Investment Corporation (AI-TSX $10.18)

An excellent yield, with good value, good management, a nice potential upside and limited downside.

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