August 23, 2018 - 10:52am EST by
2018 2019
Price: 2.38 EPS 0 0
Shares Out. (in M): 7 P/E 0 0
Market Cap (in $M): 17 P/FCF 0 0
Net Debt (in $M): -11 EBIT 0 0
TEV ($): 7 TEV/EBIT 0 0

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  • Liquidation


TZS is Canadian mortgage lending vehicle that is currently in orderly liquidation mode and trades at 25% discount to book value. Company has already liquidated majority of its portfolio and as of Q2 only has two mortgages outstanding - these mature in 2020 and 2024. Assuming mortgages are held till maturity, I estimate IRR of 12% with very limited downside. Management's track record in liquidating sister vehicle TZZ suggests possibility of a speedier liquidation at higher prices than the current BV. 

Stock liquidity is very low, so this is suitable for PAs only.

TZS book value as of Q2 stands at C$3.12/share and balance sheet is comprised of the following:

  • C$10.7m in Cash (C$1.46/share);
  • C$12.1m residential mortgage with C$1.65m provision and LTV of c. 80% due in Dec 2020 (C$1.43/share);
  • C$2.7m residential mortgage with no provision and LTV of c. 50% due in 2024 (C$0.37/share);
  • -C$1.1m incentive fee provision accounting for the liquidation proceeds at currently estimated BV (-C$0.15/share);

Although both loans are classed as performing currently, the larger one might appear problematic going forward - it already was in default before and new extension and payment schedule have been agreed recently. Full description of this mortgage can be found in Q1 results, but the latest update is that borrower has negotiated 3 year extension (with TZS and senior loan partner) with the first pay-down of C$1m, subsequent payments of $0.5m every six months and balance to be paid upon maturity in Dec 2020.

The 1st of June C$1m payment was received on time, however high interest rate on the loan (7.5% for a loan backed by real estate) clearly shows that this borrower is considered to be high risk and likely struggles to find cheaper financing alternatives. Nevertheless, couple factors suggest that full loan amount will be recovered:

  • LTV ratio is c. 80% so even if the buyer defaults, collateral is likely to fully cover mortgage value;
  • Looking at BV of the loan (i.e. net of provision) the underlying collateral covers it 1.5x;
  • Provision was calculated assuming 15% discount rate to expected cash receipts on the mortgage, rather than actual expectation that some portion of the loan will not be recovered. If the loan is eventually repaid in full, book value would increase by C$0.18 to C$3.30 (resulting in 40% upside to current share price).
  • Lastly, the successful case of TZZ liquidation (including recovery above BV on the defaulted loan after successful sale of real estate) gives confidence that collateral value in LTV calculations is not overstated and that management will sort this out favorably eventually (obviously every mortgage and underlying collateral is different, so might turn out that comparison with TZZ was not appropriate).

Besides the problematic mortgage there are few other concerns. Firstly, company already sits on C$10.7m in cash (C$1.46/share), and management has no intentions to distribute it to shareholder yet (management is getting 0.85% of gross assets, so this cash balance that does nothing nets them C$90k annually). From Q2 earnings release:

Given the limited amount of principal and interest payments expected in the future, the company intends to maintain its current cash levels until the senior position is fully repaid by the borrower. The Board anticipates making further special distributions as the two remaining mortgages in the portfolio mature or are sold, subject to reasonable expected operating expenditures and repayment of the senior loan participant.

So if the remaining two loans are not sold and mature on schedule, shareholders should not expect any distribution before 2021. This is quite different from the timely distributions seen in TZZ liquidation (and on TZS so far), so there is a chance that this statement was put in place to give management flexibility and that the distribution of the C$10.7m will happen earlier.

Management fees add up to C$200k/annually and G&A will probably be below C$400k/annually going forward. Interest income from the smaller loan is c. C$115k/annually and C$909k/annually from the larger one (however, interest from the larger loan is accrued to the loan balance rather than paid in cash). Thus if if both loans and accrued interest get repaid on schedule, there should not be any BV erosion due to operating expenses - assuming expense levels outlined above till 2020 and at C$30k for management fees and C$100k for G&A afterwards (2021-2024 with only one loan loan on BS), the company would generate incremental C$1m in cash (C$0.14/share). This should provide sufficient buffer for any final company liquidation expenses or potential incremental costs of putting mortgages in default and liquidating underlying real estate.

Expected incentive fees at current book value are already provisioned.

The IRR in this situation depends not only timely mortgage repayments and absence of any further issues but also on timing of the distributions (which is at management's discretion). I arrive at IRR of 12% assuming:

  • Mortgages and any accrued interest get repaid on schedule (2020 and 2024);
  • There are no additional BV accretion/erosion from interest income receipts or liquidation expenses (i.e. the above mentioned incremental C$1m buffer is ignored);
  • Distributions take place right after maturity of each loan (2021 and 2024).

IRR would be substantially higher if mortgages get sold prior to maturity or another asset manager offers a buyout the listed vehicle at NAV (as happened for TZZ after only one loan remained on the balance sheet).

I consider the downside to be limited at current prices mostly due to collateral protection on the potentially problematic loan as well as large discount to NAV. The underlying real estate would need to be sold at 1/3 of its estimated value for investors to break-even at current share prices (ignoring any time value of money).

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Announcement of distribution of cash on the balance sheet before maturity of the first loan.

Sale of loans before maturity.

If none of the above happens, then repayment of the problematic loan on time.

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