National Post (National Edition)
Home Capital: Did it have to get this bad?
Home Capital Group Inc. is taking steps to right its business, but, even with what by all accounts is a sound mortgage book, it may not survive the fallout from OSC accusations that it provided misleading disclosure to investors.
That the fate of Canada’s biggest alternative mortgage lender is in question, with ripple effects hitting the broader financial services sector, has led to debates in legal, government, and financial circles about how things got so bad so fast, especially when there were obvious ways of heading off such a crisis.
Legal experts, for example, are questioning why Home Capital didn’t mitigate the damage by settling with the regulator that was about to drop bombshell allegations.
They point to notable cases where companies did move on after settlements with the Ontario Securities Commission – Biovail Corp., Yorkton Securities, AiT Corp. — even though individual executives and former executives continued to fight the accusations.
Businesses, particularly regulated ones, are “loathe to have contested hearings with regulators, even when they think they are right,” said Robert Staley, a veteran securities at Bennett Jones LLP in Toronto. “They’d rather write a cheque and take a sanction than face accusations of wrongdoing.”
Staley, who is not involved in the Home Capital case, but often advises companies and boards on regulatory matters, said firms “often want to settle to put issues behind them … mitigating the reputational harm that can come from a long and contested hearing.”
An agreed upon statement of facts in a settlement allows for a “favourable spin” to be put on the conduct in question, and penalties tend to be less severe than if a panel of OSC commissioners determines securities laws were breached, he said.
Discussions took place between the OSC and company representatives before the formal allegations were made and ahead of the worst of the carnage at Home Capital, sources say.
Such talks are confidential, though a media report amid the ongoing market turmoil this week suggested Home Capital founder and former CEO Gerald Soloway had offered to settle and take the blame. However, the report did not say what sanctions Soloway offered to take that were reportedly rejected, or explain the more pressing question of why the company opted not to settle, given the impact of the formal allegations on its already slipping depositor base and share price.
Soloway did not respond to an interview request from the Financial Post, and a company spokesperson said Friday that Home Capital “has no comment” on the issue of settlement talks.
“I think a settlement would have added some certainty — pay a fine and put the past behind them,” said a Toronto-based analyst.
In its absence, the formal allegations and a long-running and vocal short-selling campaign targeting the company combined to create a “perfect storm,” the financial analyst said.
On April 19, the OSC laid out its case against Home Capital and its disclosure of fraudulent income documentation in its mortgage business. The impact in the days that followed was dramatic.
In what was termed a “run on the bank,” depositors withdrew hundreds of millions of dollars from savings accounts in less than a month, forcing Home Capital to hastily arrange an expensive $2-billion line of credit.
The company’s shares plummeted, and have since tumbled by more than 73 per cent to close Friday at $5.85, lowest in more than 10 years.
What started as a question of disclosure regarding an apparently isolated problem in 2014 and 2015 exploded into a full-blown crisis of confidence — even though by all accounts there were no problems with Home Capital’s mortgage book.
“Frankly, the mystery here is how it unravelled so quickly given that the business is still viable,” a veteran financial services lawyer with regulatory expertise told the Financial Post on Friday.
Investor concerns about Home Capital bled into other parts of the financial services sector, and even raised fears about possible cracks in Canada’s red-hot housing market.
Calming words from federal Finance Minister Bill Morneau that the two aren’t related seems to have done little to contain the fallout, which hit other alternative mortgage lenders such as Equitable Group.
Some market-watchers have criticized politicians and regulators, saying they should have done more, and sooner, to contain the issues at Home Capital — particularly since the OSC had raised the possibility of formal allegations against the lender in February.
The message could have been clearer: the health of the mortgages underwritten by Home Capital is not in question — at least not as a result of the disclosure issues of concern to the OSC.
The banking regulator, the Office of the Superintendent of Financial Institutions, took a close look at the mortgage book after Home Capital revealed the falsification of some documentation in 2015, company watchers say. Analysts also note that Home Capital’s mortgage loans tend to cover shorter terms than some banks, so many of those mortgages would have been renewed with accurate paperwork by now.
These points were well understood by financial industry veterans, politicians, and regulators. As a result, they may not have anticipated the violent public reaction to the OSC allegations.
On Friday, Morneau’s press secretary Annie Donolo declined to address whether more co-ordination, and sooner, between government and regulators such as the OSC and the OSFI would have mitigated the fallout.
“The Minister and Department of Finance continue to monitor the situation,” she said, adding that the government has “full confidence” in OSFI “to manage the situation.” She deferred to OSFI “to speak to … questions on process.”
By law, OSFI deals privately and confidentially with financial services companies, and spokesperson Annik Faucher said the banking watchdog also “maintains ongoing dialogue with other regulatory agencies.”
But sources say there was limited communication, if any, with the OSC even as it became clear the securities regulator had serious concerns about Home Capital.
Whatever contact there was, “I doubt one regulator would talk another away from doing what it felt it needed to do,” said a veteran lawyer.
Given the timing of the run on deposits, which the company said drained $591 million between March 28 and April 24, Home Capital’s customers were spooked not only by the OSC probe, but also by the sudden departure of a key executive, chief executive Martin Reid on March 27. That was less than three weeks before the OSC’s formal allegations were laid out. Reid had been with the company for about a decade.
It is unclear how the timing of the termination of Reid’s employment fits in with the OSC settlement negotiations. But securities lawyers suggest executive or director changes at Home Capital would be on the table during any such talks.
“Sometimes a company’s willingness to cut ties with targeted individuals factors into the regulator’s willingness to settle and the terms of settlement available to the company,” said Staley, the Bennett Jones lawyer.
The OSC sometimes announces a hearing to consider proposed settlements with some or all of the accused — including the firm — at the same time a statement of allegations is issued laying out the case for a full-blown hearing that can take months or even years to resolve.
Enforcement cases brought by the OSC where a company sidelined individuals and settled allegations early include investment dealer Yorkton Securities in 2001, and drug maker Biovail in 2008.
Both firms survived the regulatory probes. Yorkton later sold off its private client business and the rest was merged into another firm that eventually became part of Richardson GMP. Biovail joined forces with Valeant Pharmaceuticals in 2010.
In the case of Home Capital, the firm terminated Reid after the company had informed the market in February of the “preliminary conclusion of OSC staff that the Company failed to meet its continuous disclosure obligations.” But the two others ultimately named in the OSC statement of allegations remained with the company: CFO Robert Morton, and Soloway, who had stepped down as chief executive in 2016, was still on the board.
After the OSC’s formal allegations were made public in April, Home Capital announced that Morton would step aside from his finance role once the company filed first-quarter financials, and that Soloway would retire from the board once a replacement “with financial services expertise” was found.
Alan Hibben, former head of strategy and managing director of mergers and acquisitions at Royal Bank of Canada, was named as Soloway’s replacement on Friday.
The resumé of the newest director is also noteworthy for his earlier stint as president of a trust company that, according to Home Capital’s news release, “faced a difficult restructuring and eventual sale after previous management had been relieved.”
Home Capital has hired investment bankers to explore “strategic options,” which analysts say could lead to a sale of the company itself or its assets including the mortgage portfolio.
Ratings agency DBRS called Hibben “a highly experienced and credible director with deep relationships across the industry,” and said his appointment “is an important first step toward restoring market confidence.”
As Home Capital seeks to rebuild and the regulatory showdown with the OSC makes its way through the system, it is still possible a settlement will be reached. But it is also possible both sides will bear down for a protracted fight.
Securities lawyers say Home Capital has the strength of its board on its side. The board at one time boasted two former senior officials from the OSC, though only one remains a director.
Former OSC chair James Baillie, who was an independent director on Home Capital’s board until July of 2015, led the internal probe of the firm’s broker channel, which was dubbed Project Trillium. In addition to his own credentials, observers note, Home Capital sought and received outside professional guidance on the probe.
The firm has repeatedly asserted that it met its disclosure obligations in 2014 and 2015. “Home Capital Group has always carefully considered its disclosure obligations. The Company believes that its disclosure satisfied applicable disclosure requirements, and the allegations are without merit,” the firm said.