Quest Capital Corp (NYSE & TSX: QCC)

I found this Canadian mortgage bank, Quest Capital Corp (NYSE: QCC). It's quite an interesting company. Basically, QCC specializes in construction loans. Meaning that it lends to developers the initial loan to get the building built. These loans are inherently risky due to the numerous issues that could crop up during the construction process and as such the interest rate is also rather high. Normally, developers re-finance these loans at a lower rate once the project is complete. So these loans have a short maturity date.

QCC has
- Market cap of 139M.
- Debt of C$ 46.3M
- Preferred Shares of C$ 38.9M.
- Trading at 0.5 of book value
- Total Assets of C$ 382.824M
- Debt to Asset Ratio of 0.12
- Debt plus Preferred Share to Asset Ratio of 0.22

We are faced with a simple problem here. Banks are essentially blind investing pools, no one knows how good or how bad their underwriting standards are until it's too late. So we need to figure out how much losses they can take. QCC is unique 'coz its equity cushion is so high (78% of their asset base is funded by equity) and you are only paying 50 cents on a dollar for that equity.

The company's total asset base is C$ 382.824M. 97% of that comprises of loans (C$ 370.382M). 1% comprises of cash (C$ 3.875M). 1% - future income tax assets (C$ 4.232M). 1% - other (C$4.335M). These figures are from their Q1 report, which is the latest report available.



As at March 31, 2009, QCC’s loan portfolio consisted of 54 loans of which 51 were mortgages secured by real estate and 3 were bridge loans secured by various mining and energy related assets.



As at March 31, 2009, the mortgage portfolio was comprised of 99% first mortgages and 1% second mortgages. The above table shows the evolution of the portfolio. As at March 31, 2009, the mortgage portfolio was concentrated in western Canada, with loans in British Columbia representing 40% of the portfolio, the Prairies 46% and Ontario 14%.

Credit Quality and Non-Performing Loans

As at March 31, 2009, the Company had fifteen non-performing loans in the amount of $113.8 million (31% of their loan portfolio) (2008 - 4 non-performing in the amount of $12.6 million) on which remedial action has been undertaken. On eleven of these loans totaling $66.8 million, the Company has provided aggregate specific reserves for credit losses of $16.3 million. For the remaining four impaired loans, totaling $47.0 million, management has not provided for any specific loan losses as the estimated net realizable value of the collateral securing the loans is in excess of the carrying value of the impaired loans.

From year end 2008, QCC continued to have 14 loans which are classified as impaired and added another loan for a total of 15 loans, of which 11 have a specific loan loss provision. As at March 31, 2009, the Company’s allowance for loan losses increased to $16.3 million, mainly as a result of an increase in the specific loan loss provision related to 4 loans, 3 of which continued to be impaired from December 31, 2008.

Loan Loss provisions are as follows:

1. QCC has 3 impaired loans in the Okanagan region of British Columbia, which are primarily land loans awaiting re-development amounting to $31.9 million. As a result of further development costs to maintain the property value, QCC increased the specific provisions on one of these loans by $0.3 million.

2. QCC has a $4.7 million loan located in northern Alberta whose specific loan loss reserve has increased by $1.0 million to $1.4 million. Marketing efforts on this property to date have made it necessary to increase the reserve.

3. QCC has a resource loan for $2.7 million on which the loan loss allowance has been increased by $0.6 million to $1.9 million mainly as a result of further deterioration in the value of the collateral.

4. QCC has a residential construction loan in northern Alberta with a current net loan exposure of $6.3 million. In order to maximize value and ultimately collect on the security, Quest will continue to fund the construction until completion. Quest has taken a specific loan loss of $0.9 million on this loan.

In addition, QCC has a net loan exposure of $25.8 million on a property in downtown Vancouver, British Columbia which is currently subject to receivership proceedings. The loan continues to be classified as impaired however no provision for any loan loss has been determined as required as at March 31, 2009. An independent appraisal from a qualified third party obtained in early 2009 has a value in excess of Quest’s carrying value. However, the appraisal is based on a number of significant conditions including the condominium project being built on a timely basis, which is subject to the receivership proceedings being successfully concluded in the short term.

After all the information download onto you, there still remains the analysis that has yet to be answered. How should we analyze this company? Obviously with 31% of its loan portfolio classified as Non-Performing, this company is definitely risky. We have to wonder about its underwriting standards. On the other hand, I must also highlight that the company has a 78% equity cushion and that one is buying that equity cushion at 50 cents on a dollar. Is that worth the risk?

I've been attempting to answer that question by trying to find mortgage loan default rates in British Columbia, Ontario and the Canadian Prairies. I've not been successful. If anyone out there knows of relevant data, please please email me at shaunhhh@gmail.com. Thanks.