What exactly is Home Capital and why is it so important to the mortgage industry?

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[I read a more recent, follow-up article to this one, and decided to post an older one. I hadn't heard of this - seems like the business community is managing to keep this news contained. This sounds much like the mortgage broker fraud issue that broke out in the US during their housing bubble. It doesn't sound like this is something that can spread, but this general kind of story will be something to keep an eye on. The newer story is here: Home Capital bleeding as deposits sink below $200-million. *RON*]

Armina Ligaya, Financial Post, 27 April 2017


Home Capital Group Inc.’s shares plunged nearly 65 per cent on Wednesday, pulling down the stocks of other alternative mortgage lenders along with it. Here’s a look at the company, its role in the Canadian mortgage landscape and how the discovery of fraud among its brokers two years ago continues to have ripple effects today.

What is Home Capital? What does it do?

Home Capital is a publicly traded company which offers mortgage lending, deposits, and credit cards through its principal subsidiary, Home Trust Company. The Toronto-based lender primarily offers uninsured mortgages to clients who are turned away from traditional banks, for reasons such as an uneven credit history or because they’re self employed. These residential mortgages account for roughly 90 per cent of Home Capital’s business. Home Trust also offers deposits via brokers and financial planners, and through its direct-to-consumer deposit brand, Oaken Financial. As well, Home Trust conducts business through its wholly owned subsidiary Home Bank. Home Trust is a federally regulated trust company licensed to conduct business across Canada, and has offices in six provinces including Ontario, Quebec and British Columbia.

Related
Home Capital seeks $2 billion credit line as deposits plummet

Why is Home Capital important?

Home Capital is one of Canada’s largest alternative mortgage lenders and plays an important role in Canada’s housing market. However, it’s a small fish in a big pond. “For perspective, HCG has a sub-$20 billion mortgage book, which translates to minnow status relative to the $1.1 trillion of residential real estate credit on Big-Six balance sheets,” said Gabriel Dechaine, an analyst with National Bank of Canada Financial Markets.


Why did Home Capital’s shares plunge on Wednesday?

Investors were worried about the company’s ability to have enough funding to keep lending mortgages. Home Capital’s announcement Wednesday that it needed to sign a $2 billion loan facility to help mitigate the impact of a nearly $600 million drop in high interest savings account deposits at Home Trust triggered Wednesday’s share collapse, sending the stock down as much as 64.9 per cent to $6. It was a partial run on their funding — Home Trust’s demand deposits, as well as fixed deposits such as GICs, help fund the company’s mortgage lending. The drop in deposits and the expensive credit line were the latest stumbling blocks for Home Capital and have damaged investor confidence in the company’s long-term viability.

What started the crisis?

Home Capital’s current crisis began on April 19, when the Ontario Securities Commission accused the company and some of its officials of misleading disclosure. The OSC alleges that the company misled shareholders because it knew there was fraud in its broker channels [emphasis added] before July 2015, when it announced the findings of its internal investigations and disclosed it had cut ties with 45 brokers as a result. While these events took place more than two years ago and analysts say the underlying fundamentals are steady, the allegations have created an air of uncertainty which have resulted in real issues for Home Capital’s liquidity. “This is a very peculiar situation where Home Capital has no issues around credit, and no issues with a capital shortfall. Yet they are being decimated in terms of their viability as an ongoing entity,” said Mike Rizvanovic, an analyst with Veritas Investment Research in Toronto.

Could the problems there spread?

Analysts are worried that it could, and the resulting hit to the share prices of other alternative lenders on Wednesday indicates that investors are concerned too. “Based on Wednesday’s market action, we believe the issues at HCG may be spreading into the broader broker GIC and alternative mortgage markets,” said Stephen Boland, an analyst with GMP Securities, in a note on Thursday. Equitable Group’s shares closed down 31.65 per cent to $40.75 and Genworth MI Canada shares were down 7.87 per cent to $33.12 on Wednesday. However, these companies’ shares rebounded on Thursday, with Home Capital shares rising 33.89 per cent to close at $8.02 in Toronto. Equitable shares closed at $43.88 (up 7.81 per cent) and Genworth shares closed at $34.02 (up 3 per cent). Street Capital was virtually unchanged, closing at $1.21 in Toronto. “Home Capital contagion has spread to the entire mortgage market, in particular alternative mortgage lenders,” said Jaeme Gloyn, an analyst at National Bank of Canada Financial Markets, in a note downgrading Equitable Group and Street Capital Group on Thursday. “Our channel checks suggest EQB’s deposit-gathering capabilities will be impaired.”

Will the Government need to step in?

The Office of the Superintendent of Financial Institutions, which regulates banks and trust companies in Canada, is “monitoring the situation closely”, a spokeswoman told the Financial Post in an email on Wednesday. Boland said Thursday “regulators may move quickly to protect the alternative mortgage market confidence and depositors.” Still, “it may be several months for the current situation to play out and determine whether HCG can turn the corner or if it will face the prospect of winding down its operations,” Jeff Fenwick, an analyst at Cormark Securities, told clients in a research note Wednesday. Demand deposits like the high interest rate savings accounts represent roughly 13 per cent of Home Capital’s funding, but it is its fixed deposit products such as GICs that make up a significant portion of its funding sources, said Rizvanovic. “That’s the last shoe to drop. if that starts to go, then they don’t have a viable business structure any more. They can’t exist… that’s the last unknown.” They’re not too big to fail, he added. “The market will continue with or without Home Capital,” said Rizvanovic. However, regulators are unlikely to stand by and watch a Canadian lender disappear, he said. “If there is a situation where there is risk around this company not able to renew clients that are up for renewal, then OSFI would have to step in. Although, that doesn’t look to be the case, at least in the short term.”

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