Five key questions Home Capital has left to answer
Lender to face day of reckoning from shareholders, Armina Ligaya writes.
Executives at Home Capital Group Inc. will face the company’s shareholders Thursday for the first time since a crisis of confidence pushed the alternative mortgage lender to the brink of collapse in May.
But even with a rescue package from Warren Buffett, which will see a subsidiary of the legendary investor’s Berkshire Hathaway invest up to $400 million while extending a $2-billion line of credit, it may be too soon to take a victory lap.
On Tuesday, shares of Home Capital slipped more than eight per cent to close at $16.22, after surpassing $20 in the aftermath of the Buffett deal last week.
“Some of the euphoria has come off,” said Mike Rizvanovic, an analyst at Veritas Investment Research.
While the company’s deposit base has stabilized and having Buffett as a sponsor has boosted its reputation, other issues remain, such as the impact of tighter government regulations on the Toronto real estate landscape where Home Capital’s exposure is the largest, said Rizvanovic.
“Now, they’re in the grips of a residential housing market locally — which they’re pretty dependent on — potentially changing materially in the next couple of years,” he said. “There are so many uncertainties with respect to their earnings power going forward.”
Ahead of Thursday’s annual general meeting, here’s a look at five key questions still hanging over Home Capital.
1)
Who will run it?
Bonita J. Then has served as Home Capital’s interim chief executive since the company terminated Martin K. Reid abruptly at the end of March. Reid was one of three former executives, along with founder Gerald Soloway and former CFO Robert Morton, who were named in the Ontario Securities Commission’s allegations of misleading disclosure that were ultimately settled this month. Executive search firm Caldwell Partners has been tasked with finding a new chief executive and chief financial officer, and Home Capital has said it aims to name a new CEO sometime in July. Buffett’s involvement and the stabilized deposit balances in recent days has likely improved the calibre of interested candidates, said Rizvanovic. “You can more easily entice someone over,” he said. Last week, Bloomberg reported that director Alan Hibben is among the candidates.
2)
Can they rebuild their deposit base?
Home Capital’s Guaranteed Investment Certificate balances — which support a large portion of its mortgage lending — have risen for five straight days to $12.0835 billion as of June 26, but that’s still more than $1 billion below where they stood March 28. High interest savings account balances, which have dropped from $1.991 billion on March 28, held steady at $111.8 million on June 26. Analysts say the Buffett effect could go a long way toward rehabilitating depositor confidence, but it has taken a higher interest rate to begin to entice them back as well. Home Capital’s direct-to-consumer channel Oaken is offering a one-year GIC at 2.75 per cent, compared to 1.55 per cent for Equitable Bank. “If this is the new normal for these guys, if they have to be 100 basis points higher than all their competitors, that’s just going to dent their earning power,” Rizvanovic said.
3)
Will shareholders approve Buffett’s second tranche?
The Oracle of Omaha’s rescue package involved an initial investment of more than $153.2 million to acquire more than 16 million common shares at $9.55 per share. But a follow-on investment for an addition 24 million shares at $10.30 per share requires a shareholder vote, and analysts are skeptical that the second tranche will win support at a special meeting in September, given the share price movement since. Hugo Chan, the chief executive of shareholder Kingsferry Capital, said he would vote in favour as “more skin in the game” for Berkshire is a positive for Home Capital. Shareholder David Taylor, the founder and chief investment officer of Taylor Asset Management Inc., however, said he doesn’t see the benefit for the added dilution. “We already have Buffett, and the aura of Buffett . ... It doesn’t all of a sudden become uber Buffett,” he said.
4)
What happens if Toronto housing softens?
Federal government measures aimed at cooling down the housing market last fall and a 16-point plan introduced by the Ontario government in April appear to be having the desired effect. Average home prices in Toronto are now down roughly 12 per cent from their April peak. “Given HCG’s ~86 per cent weighting to the Ontario market, these data points should increase to investors’ top-of-mind as they think about HCG going forward,” said Jaeme Gloyn, an analyst with National Bank Financial in a note to clients last week.
5)
What happens if interest rates rise?
Home Capital Group and other alternative mortgage lenders have already increased mortgage rates on renewed and newly originated near-prime, also known as Alt-A, mortgages by 50 to 150 basis points “in sympathy with higher GIC funding costs,” said Gloyn, based on the analysts’ conversations and channel checks. With the Bank of Canada signalling an interest rate rise is on the horizon, National Bank Financial economists now expect rates to rise twice, or by 50 basis points, by the end of the calendar year to one per cent. Home Capital’s customer base, which typically don’t qualify for loans at traditional banks, are in for a potential interest rate shock. “Layering this on the increase to near-prime rates could mean near-prime borrowers face a 100 to 200 bps interest rate shock.” That Gloyn said, could translate into monthly payments that are 12 per cent to 25 per cent higher.