Betting on failure of Home Capital
Marc Cohodes has wagered the alternative mortgage lender will not survive meltdown
“I’ve had Cott up there. I’ve had Clearly Canadian. Made a killing. I go back with Kevin O’Leary — Learning Co. and Softkey before that. I had a double dip with Garth and Cineplex Odeon and Livent. Melnyk with Biovail. Canada is great. Canada has been wonderful.”
This is Marc Cohodes running through his set list of Canadian stocks he has shorted — that is, bet against — at various stages of his career, stages that have taken him through fame, great fortune, an alleged short-selling conspiracy, liquidation of his hedge fund, a period of what reads like self-imposed exile raising chickens in California and now a very public one-man attack on Home Capital Group Inc., and by extension Home Capital’s subsidiary, Home Trust.
The Toronto-based alternative mortgage lender is at the epicentre of a confidence-draining, deposit-shrinking, liquidity crisis maelstrom that has the potential, as the company admits, to negatively effect the Canadian financial system.
“Everybody is interested in trying to do the right thing systemically for Canada,” new board member Alan Hibben said in a conference call with analysts Friday.
“If this company were to not succeed it would have significant knock-on effects, particularly to new Canadians and others who this company services.”
The company’s “niche” is the non-prime mortgage market not conventionally serviced by the Big Five banks. On Friday, a Home Capital executive said that between 25 and 30 per cent of the estimated $1.4trillion dollar Canadian mortgage market is composed of consumers who fall out of the prime lending “space.” And Home Capital says it has roughly 5 per cent of that.
Clearly the high calibre of incoming management and new members to Home Capital’s board of directors — a not yet complete “refresh,” as the company calls it, that includes the highly respected Claude Lamoureux, past CEO of the Ontario Teachers’ Pension Plan — reflects a broad-based concern throughout the financial system that the company can’t be allowed to fail.
Marc Cohodes is betting that it can and will.
“I think when the chapters are written somewhere down the line of exactly what went on, people are going to be absolutely aghast as to what went on here,” he says. “Just absolutely floored. When the stories are finally told. When the autopsy is done on this thing. When it’s in the morgue.”
The potential victims here are not the richly departed Home Capital executives, but the fragile mortgage holders wondering if their mortgages will be renewed and if so by whom. It is these homeowners who were promised the fulfilment of what board chair Brenda Eprile calls “the dream of home ownership.” As we now know, that dream was in many cases fraudulently fulfilled via dozens of now excommunicated mortgage brokers who submitted bogus employment income documentation for borrowers in order to secure those mortgages.
It is this that gives the Home Capital crisis a whiff of the U.S. subprime, no-doc mortgage crisis of a decade ago. And it is the lack of timely disclosure of these matters, and the negative impact on new mortgage originations, that underpin Ontario Securities Commission allegations that Home Capital breached its disclosure obligations under the securities act. Home Capital says that those allegations are without merit.
Marc Cohodes didn’t have a clue about the income fluffing. As a veteran short-seller he listens to the calls of other short sellers, and when famed short-seller Steve Eisman presented Home Capital as a “short idea” at a New York investor conference in the spring of 2013, Cohodes started paying attention.
According to one account, Eisman defined Home Capital to the crowd as the largest non-prime mortgage originator in Canada that could have serious problems “if housing rolls over.”
Except housing in Canada showed no signs of rolling over. Still, it was the same Steve Eisman who famously bet against the squirrelly U.S. mortgage market and then more famously became one of the subjects of Michael Lewis’s The Big Short, followed by a more famous still characterization by Steve Carell in the movie of the same name.
Cohodes watched. While Eisman went short, Cohodes didn’t until 2014, when the company reported “consistent” — a.k.a., flat — results for the third quarter over the prior quarter. He recalls the stock was $53 at the time.
The brakes appeared to be on mortgage origination. But Cohodes had no idea why. Other short plays involve incredibly detailed forensic examination of the numbers. In the early ’90s, the shorts, including Cohodes, were all over Gerry Pencer’s Cott Corp., picking through such areas as the pop maker’s “deferred development costs,” which the shorts said was just a technique to inflate profits.
Most famously, Jim Chanos took on Enron Corp., shorting what turned out to be a massive fraud. To those who castigated short sellers as a blight on the system, Chanos defined short sellers as detectives and regulators as expert in archeology. Enron proved him right.
In the case of Home Capital, Cohodes appears first to have moved on gut instinct rather than details. “I had zero inkling,” he says of the internal troubles. “So I would say that my timing was very lucky. But I’ll take it. I’ll take it.”
But then there was a wave of departures — “a big tell for me,” he says. “Enough people left, I got a hold of enough people, and started piecing together the back story, and the back story was horrifically ugly.”
He won’t say which Canadian authorities he has been in touch with, if any. “There’s a soup of people up there,” he says. “I’m not going to kiss and tell, but I view myself as a whistleblower in a few matters.”
He has received unsigned mail at his California chicken farm encouraging him to keep pushing on the Home Capital story. Except there’s really nothing more for the shorts to say. By Friday Cohodes was lining up his next short and readying for a European getaway, while Home Capital was studying what a board member called “scenarios out the yin-yang” for the company’s salvation. jenwells@thestar.ca