Why This TSX Mortgage Lender May Underperform in 2020

MCAN stock may lag the market if an economic recession drives mortgage defaults higher.

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The world economy has come to a halt. Quite a few comparisons have been made between the pandemic-driven slowdown and the 2008-09 financial crisis. However, there are major differences between then and now. Even though the economy took a hit in 2008-09, business never stopped. Airlines continued to fly, malls were open, students attended schools and colleges, and offices were functioning.

As the last month of Q2 gets underway, the “Financial System Review – 2020“, a report by Bank of Canada, talks about the impact of COVID-19 on the Canadian financial system. The part of the report that talks about mortgages and households is not pretty.

The report says, “About 20 percent of all mortgage borrowers do not have enough liquid assets to cover two months of mortgage payments.” This is despite the loan payment deferrals that have been offered to households to help them bridge the loss of income from job losses or furloughs.

It further states, “Canadian banks have allowed more than 700,000 households to delay mortgage payments and have also provided increased flexibility on payments for credit cards and lines of credit.”

This stop-gap solution has worked well so far. However, once the six-month deferral period ends, households will find it difficult to service their debts. The number of households that spend more than 40% of their income servicing debt is likely to rise. Further, if the households can’t recover their pre-pandemic incomes, they will be in serious trouble.

Unemployment rates are a concern for this TSX

Approximately 15% of the workforce is unemployed. Around 16% are employed but have lost the majority of their working hours. The Financial System Review (FSR) says that a pattern will be observed where customers begin to default on their credit card payments first, auto loan payments next, and then on mortgage payments.

According to FSR, “The situation in Alberta and Saskatchewan, where the share of households that fell behind on their payments had already been increasing, is of particular concern.”

Bad news for mortgage lenders

These developments don’t spell good news for mortgage lenders who will see a prolonged period of pain as customers get back on their feet. I had written about Home Capital Group’s problems in this space, and when I took a look at MCAN Mortgage’s (TSX:MKP) results, my belief was fortified.

The company reported a net loss of $9.7 million for the first quarter of 2020. In the prior-year period, its net income stood at $14.3 million. An alarming point to note here is that the company “recorded a $15.7 million net loss on securities compared to an $8.0 million net gain on securities in the first quarter of 2019, due primarily to fair value changes” in its real estate investment trust portfolio. This means that the news was bad even before the pandemic.

MCAN’s mortgage arrears clocked in at $36 million on March 31, 2020, from $16 million on December 31, 2019. When you look at Bank of Canada’s report, all signs point to a worse Q2. To say that Q2 will be a rough quarter would be an understatement. This means the company can also cut its dividends if the situation worsens. MCAN has a forward yield of 10.3%. The stock is trading 24% below its 52-week highs.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Aditya Raghunath has no position in any of the stocks mentioned.

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