Lender’s drama may soon spread
Home Capital’s expected downsizing has far-reaching implications for the industry
In a slimly illuminating attempt at restoring investor confidence, embattled Home Capital Group Inc. has announced that some person or party (unnamed) has indicated his, her or its intention (non-binding) to purchase $1 billion (or thereabouts) in uninsured mortgages from subsidiary Home Trust, expressing an immediate “interest” in purchasing (or accepting commitments for) up to half that amount. Further, this “third party” has indicated an intention (also non-binding) to purchase $500 million in insured mortgages “subject to appropriate documentation.”
The timing of all this opacity is clear enough: Home Capital is set to release its first-quarter results Thursday followed by what promises to be a contentious investor conference call Friday morning. The hoped for off-loading of some of its mortgage portfolio is part of a multi-pronged strategy to reassure the market that it will continue to command a prominent place in the “mortgage broker channel.”
This ongoing corporate reshaping, in train for more than two years, now extends from a freshly recomposed board of directors to “tightening our lending criteria and reducing some of our broker incentive programs.” As a result, the company expects a decline in mortgage originations and renewals. In other words, a downsizing of its core business.
As we now know, the lustre of Home Capital’s branded promise — servicing the needs of mortgage borrowers who don’t meet the qualification requirements of the big banks — was tarnished way back in June 2014, when the company became aware of application irregularities in the underwriting of mortgages. After launching an internal investigation — Project Trillium — the focus turned to mortgages that had been approved on the basis of fraudulently claimed employment income.
As a result, 30 brokers and two brokerages were terminated.
In 2014 alone, those brokers originated more than $880-million worth of mortgages, representing about 10 per cent of Home Capital’s entire origination book that year.
What Home Capital did not do, the Ontario Securities Commission alleges, is meet its continuous disclosure requirements.
The company failed to disclose material changes in a timely manner, the commission alleges, and made misleading and untrue statements in its analysts’ earnings call two years ago, blaming the declines in originations for the first quarter of 2015 on factors ranging from cold weather to macroeconomic conditions.
Home Capital contends that its disclosure “satisfied applicable disclosure requirements,” and insists the allegations will be “vigorously defended.”
In its release yesterday, it said the previously announced $2-billion credit lifeline led by HOOPP (the Healthcare of Ontario Pension Plan) was syndicated to a group of investors, including the Fortress Investment Group.
The Home Capital drama does have macroeconomic implications to the degree that it begs questions around that part of the mortgage market that continues to be underserved by the big banks. Paul Smetanin, president of the Canadian Centre for Economic Analysis, says his group estimates that the unregulated and subprime market in the Greater Toronto and Hamilton Area (GTHA) could be as high as 14 per cent.
What we don’t know is the level of vulnerability, at least not entirely.
It’s worth keeping a bit of history in mind. Eleven years ago, the Canada Mortgage and Housing Corp. (CMHC) announced serial moves in response to aggressive competition from the likes of Genworth Financial. CMHC announced that it would offer insurance on interest-only mortgages for up to the first 10 years. In June 2006, it announced that its trial 30-year mortgage loan insurance had been such a success that insurance would be offered on 35-year amortizations. That was then increased to 40 years. Madness and risky, as I wrote then.
Insurance is no longer available on mortgages with longer than 25 years, but still the government wore a reputation equivalent to a mortgage drug dealer.
The thought that home ownership was an accomplishment to be earned seemed out of fashion. Historically low interest rates fuelled the rise in home ownership. The subsequent explosive rise in house prices in markets like the GTHA reinforced a new notion that a mortgage wasn’t debt, but rather wealth.
Troops of economists and the Bank of Canada (BOC) have been warning about the potential shocks should interest rates increase. Higher qualifying rates for insured mortgages are meant, the BOC said in December, to serve as a “throughthe-cycle” stress test of precisely that eventuality.
But then what? “Borrowers affect- ed by any of the new rules may seek out less-regulated, higher-cost lenders, such as mortgage investment corporations and private mortgage lenders,” the BOC said in its Financial System Review. “Since these lenders are not subject to OSFI regulations and, unlike mortgage finance companies, do not use mortgage insurance, they are not constrained by the new rules. Careful attention from authorities will be needed to monitor any increase in vulnerabilities resulting from greater use of alternative lending channels.”
To be clear, Home Trust, the mortgage offering subsidiary of Home Capital, is federally regulated. Regardless of the outcome of the OSC’s investigation, the tightening of its mortgage requirements is bound to have ripple effects on the market. This could be the beginning of a much bigger story. jenwells@thestar.ca