HOME TRUTHS

Could the crisis with mortgage lender been avoided?

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 the Ontario Securities Commission 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 of 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 chief executive 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 firm opted not to settle, given the impact of the formal allegations on the company’s already slipping depositor base and share price.

Soloway did not respond to an interview request, 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 at Friday at $5.85, its lowest point 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 the 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 said.

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.

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.

On Friday, Morneau’s press secretary Annie Donolo declined to address whether more coordination, and sooner, between government and regulators such as the OSC and the OSFI would have mitigated the fallout.

She deferred to OSFI “to speak to … questions on process.”

By law, OSFI deals privately and confidentially with financial services firms, and spokesperson Annik Faucher said the watchdog also “maintains ongoing dialogue with other regulatory agencies.”

But sources say there was limited direct 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.

Home Capital 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 in a statement the day the OSC laid out its case. “The allegations will be vigorously defended.”

Some market watchers have criticized politicians and regulators, saying they should have done more, and sooner.

TORONTO The chairman of the board of the Registered Deposit Brokers Association is guiding clients away from putting money in Home Capital Group Inc.'s Guaranteed Investment Certificates (GICs) until the embattled mortgage lender's problems “sort themselves out.”

Brian Evans, owner of Evans Financial Services in Uxbridge, Ont. and a registered deposit broker, said he would expect the association's base, which has roughly 1,100 members across Canada, to also play it safe.

“If I had a client come in today with funds to invest, I might not consider using Home Trust at the moment until we see how things sort themselves out ... Generally I wouldn't use a company that's in concern at the moment, if I can help it,” said the RDBA chairman.

Home Capital has been mired in liquidity problems and its shares have plummeted since the company and some of its current and former executives were accused by the Ontario Securities Commission on April 19 of misleading disclosure, alleging they knew there was fraud in its mortgage broker channel months before the company made public announcements about the problems in July 2015.

Home Capital has said the allegations are “without merit” and it will “vigorously defend” its approach to disclosure during the OSC proceedings, which began on Thursday.

Analysts warn that Home Capital's viability hinges on the company's ability to raise GIC deposits — a major source of funding for the mortgage lender. Home Trust Company is its principal subsidiary, which can receive deposits such as high interest savings accounts and GICs via brokers and financial planners, as well as through its direct-to-consumer channel Oaken Financial.

“We believe HCG's ability to raise GIC deposits and maintain operations is uncertain,” said Stephen Boland, an analyst at GMP Securities, in a note to clients on Friday. “Without GIC funding, a run off scenario or sale/breakup is possible.”

Home Capital said last week it has retained RBC Capital Markets and BMO Capital Markets to “advise on further financing and strategic options.”

Home Capital obtains about 70 per cent of its funding from the deposit broker network, five per cent from institutional deposit notes, and the rest from its own Oaken branded direct-to-consumer savings accounts and GICs, according to Raymond James.

Since the allegations, which have not been proven, emerged, Home Capital has faced a partial run on its funding with clients withdrawing their money from high interest savings accounts at Home Trust. These balances — which have fallen from $1.4 billion on April 24 to $391 million on May 1 — help fund Home Capital's mortgage lending. This pushed Home Capital to seek a $2 billion credit line as an emergency backstop, but at costly terms that analysts pegged at an effective rate of 22.5 per cent for the first $1 billion (which it drew on earlier this week).

Home Capital's total GIC deposit balances, including Oaken and broker GICs, have fallen slightly. Those balances stood at $12.86 billion on April 28, compared to $13.06 billion on March 28.

However, 52 per cent of those GICs are due to mature in one year, according to Mike Rizvanovic, an analyst with Veritas Investment Research in Toronto.

Last month, Home Capital said Bank of Nova Scotia briefly pulled Home Trust's GICs from its offerings but intended to reinstate it that day, but with a $100,000 cap to match the upper limit of Canada Deposit Insurance Corp. coverage.

“Home Trust deposit products remain available through most leading Canadian financial institutions,” the mortgage lender said on April 24. “Some of these (including Scotiabank) have instituted a cap of $100,000 — the upper limit for Canada Deposit Insurance Corp. insurance,” Home Capital said.

Evans said he, and other deposit brokers, generally guide their clients to keep below the $100,000 CDIC threshold per institution, even before Home Capital's liquidity issues.

Bill Ritchie, chief executive of one of the country's bigger deposit brokers GICDirect.com, said his company hasn't “felt any kind of panic from our clients to get out.”

The large majority of its Home Trust GICs are well below the $100,000 threshold, and some clients renewed their deposit products with the embattled mortgage lender's subsidiary this week, he said from Vancouver, where GICDirect is based.

He is supportive of Home Trust but if a client wanted a new GIC from the company at this time, Ritchie would inform them of Home Capital's financial situation and remind them of the CDIC insurance limit.

“We're not going to tell them not to go there, but provide them with all the information and let them decide . ... At this point, we're monitoring it very closely,” he said. “I don't imagine we'll see a lot of new money going into Home Trust right now, and that might be an issue.”

We believe HCG’s ability to raise GIC deposits and maintain operations is uncertain.