Buffett agrees to $400M bailout
Billionaire investor taps into formula he used to prop up lenders like Goldman Sachs
Warren Buffett has become the lender of last resort for Home Capital Group Inc. The billionaire investor agreed to buy shares at a deep discount and provide a fresh credit line for the Toronto-based mortgage company, tapping a formula he used to prop up lenders from Goldman Sachs Group Inc. to Bank of America Corp.
Buffett’s Berkshire Hathaway Inc. will buy a 38-per-cent stake for about $400 million and provide a $2-billion credit line with an interest rate of 9 per cent to backstop the embattled lender, Home Capital said late Wednesday in a statement.
The interest on the one-year loan would net Berkshire at least $180 million if it’s fully tapped.
“While the terms of the new credit line with Berkshire Hathaway remain harsh, we believe the purpose of this loan is to motivate Home Capital’s management to bolster their own funding sources,” said Hugo Chan, chief investment officer at Kingsferry Capital in Shanghai, which owns shares in Home Capital. “This again shows Mr. Buffett’s masterful capital allocation skills,” Chan said, citing his investment motto: “be greedy when others are fearful.”
The financial backing from Buffett comes at a cost, in keeping with his past bailouts of financial firms. Buffett has buoyed some of the biggest U.S. corporations in times of trouble, including a combined $8-billion (U.S.) injection to prop up Goldman Sachs and General Electric Co. when credit markets froze during the 2008 financial crisis.
Berkshire’s purchase of $5 billion of Goldman Sachs preferred stock paid Buffett’s company an annual dividend of 10 per cent, and the billionaire also got warrants he later used to get more than $2 billion of the bank’s shares in a cashless transaction.
In the Home Capital deal, Buffett’s firm agreed to pay an average price of $10 (Canadian) a share, a 33-per-cent discount to Wednesday’s closing price of $14.94. Berkshire would become the largest shareholder in Home Capital, which has a market value of about $1 billion.
“If you have the Warren Buffett seal of approval, people will take you more seriously than if you don’t,” said Keefe, Bruyette and Woods analyst Meyer Shields. “So you sort of look beyond the settlement and say, ‘OK, what matters most now is that Warren Buffett trusts this company. And that in turn, allows Warren Buffett to get much better returns on capital than maybe some other lender would have been able to.”
The $2-billion credit line is only marginally cheaper than the emergency credit provided by the Healthcare of Ontario Pension Plan, termed by company directors as “costly.”
Under the new credit agreement, the interest rate on outstanding balances will fall to 9.5 per cent, from 10 per cent under the HOOPP line. The rate will drop to 9 per cent after the initial investment is completed. The standby fee on undrawn funds will dip to 1.75 per cent from the current 2.5 per cent, then fall further to1per cent. The credit line is for one year. Home Capital has drawn about $1.65 billion from the HOOPP loan.
The investment “is a strong vote of confidence,” in the long-term value of the business, Brenda Eprile, Home Capital’s chairperson, said in the statement.
The move is the latest sign of a turnaround in the 30-year-old lender after regulators in April accused it of misleading shareholders on mortgage fraud, which sent its shares tumbling, sparked deposit withdrawals and threatened to disrupt Canada’s real-estate sector. Earlier this week, Home Capital agreed to sell a portfolio of commercial mortgages to affiliates of KingSett Capital Inc. for $1.16 billion in cash.
“Home Capital’s strong assets, its ability to originate and underwrite well-performing mortgages and its leading position in a growing market sector make this a very attractive investment,” Buffett said in the statement.
The share purchase will be done in two parts: an initial investment of $153 million for about a 20-per-cent equity stake, then an additional investment of $247 million, taking the stake to about 38 per cent. The second phase requires extra approvals.
Berkshire will not be granted any rights to nominate directors and has agreed to only vote shares representing 25 per cent of the company’s stock, Home Capital said.
Home Capital shares have tripled since bottoming in May when its troubles began to accelerate, though remain down about 73 per cent from their peak in 2014. The company last week took full responsibility over allegations the lender misled shareholders about mortgage fraud and agreed with three former executives to pay more than $30 million to reach settlements with regulators and investors.
Home Capital directors said on a conference call Thursday the focus on the deal with Berkshire was to restore investor and capital markets confidence. The lender chose Buffett’s firm because the name would help restore confidence, even with the high price paid. There were about 70 parties looking at the company and its assets, and the board had several options in front of them including a sale of the entire firm, they said on the conference call.
“If you have the Warren Buffett seal of approval, people will take you more seriously.” MEYER SHIELDS ANALYST