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How Counsel doubled its stock price by betting on mortgages

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Counsel Corp. has managed a feat few companies ever achieve: It has a stock price that has doubled in less than a year.

The on-fire share price is a sign that investors are warming to the restructuring story at Counsel, one of the country's largest financial firms serving mortgage brokers, ranking just behind industry leaders Bank of Nova Scotia and First National Financial Corp. Although the stock has been on a tear, some analysts believe the Counsel rally is still in its early days.

"This should be a four or five bagger," contends Fred Westra, an analyst at Industrial Alliance Securities, referring to shares that rise by that multiple. He calls the company his "top pick," or best investment idea.

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Up until now, Counsel hasn't been on the radar screens of most investors, and for a good reason. The company has run a hodgepodge of mostly low earning, unrelated businesses and had a share price that languished under $1. Besides the mortgage division, Counsel has interests in a furniture manufacturer, a distressed asset sales company, and real estate properties.

Investor complaints about the lack of a clear corporate direction led management to announce a plan earlier this year to sell most of its holdings and focus on its crown jewel, its mortgage operation, Street Capital Financial Corp.

Counsel has also applied for a licence to become a bank and last month, in another boost for its refocused strategy, received Canada Mortgage and Housing Corp. approval to securitize mortgages – in other words, bundle them into tradable securities.

Counsel had $6-billion worth of mortgage financings last year, or about 3 per cent of the market. Counsel typically doesn't hold the mortgages it obtains from brokers, but offers them for a fee to other institutions, such as pension funds and life insurers.

While Counsel's market share is "small for a bank ... it's large for a company with a market capitalization of $150-million," says Mr. Westra. He has a $2.70 a share target for the next 12 months. He says Counsel's mortgage team, drawn partly from bank alumni, is "best in class" and has created a major force by catering to mortgage brokers over the past five years.

Since 2008, the mortgage operation has gone from being a startup to having $13.3-billion in assets under administration. Mortgage totals have grown at a compounded annual rate of 62 per cent since mid-2011, with no apparent sacrifice in loan quality. Only 0.2 per cent are in arrears, a figure that compares well against the banks.

The company's growth has been helped because Canadian Imperial Bank of Commerce has pulled back from the mortgage broker field and additional market share has come from brokers defecting from ING, following its acquisition by Bank of Nova Scotia.

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The prime reason Mr. Westra sees for investing in Counsel is that its dramatic mortgage volume growth represents an enormous, latent source of future profitability. When mortgages come up for renewal, the company doesn't have to pay fees to brokers, as it does when the loans are initiated, and consequently "rollovers," as renewals are called, have lush profit margins.

Mr. Westra estimates that when last year's business comes up for renewal in four years, it could generate about $50-million in pretax earnings, more than double the $18.5-million reported for all 2012. "What is compelling for me is that this is on business that's already written, without any expansion in spreads, without any growth," he says.

Another bull is Dylan Steuart, an analyst at Stonecap Securities, who rates it a "buy." He says Counsel is trading at about nine times this year's profits, compared to figures of more than 10 at the big banks, while having a superior growth outlook. In a recent note to clients, he says Counsel will benefit from "continued growth of mortgages under administration, which should provide a steady stream of high margin renewal originations in fiscal 2014 and beyond."

One knock against Counsel is that it doesn't pay a dividend, but that may change. Mr. Westra estimates Counsel has 75 cents to $1 a share in value from the non-core assets to be sold and from tax-loss carry forwards. Once the sales are completed, it will have the flexibility to start a payout.

A successful bank application could give the shares an additional boost. Given the volume of mortgage business it conducts, Counsel will be able to lever relationships with customers by offering other services, such as credit cards, if it is able to get bank status.

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