National Post


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Home Capital helped fund its new mortgages with demand deposits such as high interest savings accounts or fixed products such as Guaranteed Investment Certificat­es (GICs), offering a higher yield than the big banks for the added risk.

By 2001, the company was thriving on customers with spotty credit. Its return on equity in that year was 24.8 per cent — far outpacing the big banks’ then average of 17.6 per cent.

“I think it’s a real gem,” said Bob Leshchyshe­n, then an analyst with Northern Securities, was quoted as saying at the time

During the financial crisis of 2008, shares of Home Capital slumped — along with the market.

Yet despite worries about riskier mortgages and where that path had led south of the border, Home Capital’s model proved resilient, and Soloway’s company continued to grow.

Amidst the worst recession in 80 years, earnings per share rose from $2.59 in 2007 to $4.15 in 2009.

By 2010, economists and industry players were warning that the Canadian housing market was getting overheated.

But when Ottawa did tighten mortgage lending rules in 2012 and the big banks started pulling back from the non- prime mortgage market, Home Capital stepped into the void and picked up even more business.

On, Aug. 22 2014, Home Capital shares reached a peak of $55.75 on the TSX, a surge of 71 per cent in a single year.

The company, however, was also facing increased scrutiny. It was seen as vulnerable to market instabilit­y and, critics said, would be among the first to get hit if the bubble were to burst.

Cohodes, who used to work for U. S. hedge fund Copper River Management and has had several highprofil­e shorts over the years, had Home Capital on his radar as far back as 2012.

But it wasn’t until November 2014, when Home Capital’s quarterly earnings fell short of analyst forecasts, that he says he first bet against it.

“The housing market was very strong, and I’m thinking, ‘ Hmm, this is my chance.’ Because when business and the macro is really good, you shouldn’t be missing a quarter,” he said.

His timing, it would seem, was uncanny.

That same month, behind the scenes, Home Capital had already started termin- ating relationsh­ips with some of its brokers, according to the statement of allegation­s filed against it by the OSC.

According to the OSC’s timeline of events, Home Capital had become aware of i rregularit­ies associated with applicatio­ns for their insured mortgages as far back as June 2014. Two months later, it claims Home Capital launched an internal investigat­ion dubbed “Project Trillium” to examine fraudulent employment income documentat­ion, a probe overseen by special committee of its board of directors.

“The findings of Project Trillium highlighte­d the scale of the fraudulent documentat­ion flowing through HCG, and the serious systemic underwriti­ng control deficienci­es within HCG,” the OSC says.

And by February 10, 2015, the securities watchdog says Home Capital was finishing up the six- month probe and had cut ties with four underwrite­rs, two brokerages and 30 brokers.

These brokers were integral — they had a cumulative total of $ 881.4 million in mortgage originatio­ns in 2014, or roughly 10 per cent of all of Home Capital’s originatio­ns that year.

But, when Home Capital filed its 2014 annual financial statements that month, the OSC alleges the company made materially misleading statements, blaming the decline on “external vagaries such as macroecono­mics, seasonalit­y and competitiv­e markets.”

“Within HCG, it was known that the decline could not be attributed solely to the external factors,” the OSC says.

None of the allegation­s have been proven, and the company has vowed to defend its approach to disclosure to the OSC.

It wasn’t until July 2015 that the general public heard something was amiss.

Home Capital publicly announced on July 10 that an ongoing review of its business partners had led it to terminate certain brokers, causing an immediate drop in mortgage originatio­ns. The next day, Home Capital’s stock price fell by 18.9 per cent — erasing $600 million from its market capital.

Speculatio­n and criticism on Twitter by short sellers — including Cohodes — about who, or what, precipitat­ed the terminatio­ns ran wild.

On July 29, 2015, at the request of the OSC, Home Capital released a statement saying that an external source had told its board about possible discrepanc­ies in income verificati­on informatio­n submitted by certain brokers.

“The i nvestigati­on determined that falsificat­ion of income informatio­n had occurred but that there was no evidence of falsificat­ion of credit scores or property values,” Home Capital said at the time, adding that it had cut ties with 45 individual brokers.

Home Capital later tried to assure the market that despite the fraud, the mortgages were solid.

Soloway said in November 2015 that most of the borrowers that came through those brokers had healthy credit scores and were not missing mortgage payments.

By January Home Capital shares were rising again.

In March 2016, Soloway announced he was stepping down from his role as CEO after 30 years but would remain on its board. During his tenure, Home Capital grew from a dozen employees and about $51 million in assets to more than 870 employees and more than $ 25 billion in loans under administra­tion.

That l egacy, however, would soon face additional questions.

In October, new federal government mortgage rules required that Canadians prove they could pay at a higher rate than they would actually be paying, to mitigate the impact of any rise in interest rates. Home Capital warned that these new rules could result in a decline of up to 60 per cent of its insured mortgage business.

In February and March, Home Capital said that the OSC had served the company and some of its former and current directors with enforcemen­t notices, charging that it “failed to meet its continuous disclosure obligation­s” in 2014 and 2015.

“The Company believes the claim is unfounded and intends to vigorously defend the claim,” Home Capital said in a statement in March.

Home Capital then fired its longtime president and Soloway’s successor as CEO Martin Reid on March 27, and removed him from the boards of directors from the company’s subsidiari­es. The sudden dismissal sent Home Capital’s shares tumbling by 9 per cent.

The OSC filed formal allegation­s against the company on April 19 and Home Capital shares continued to fall.

This week, the f allout came to a head when Home Capital said deposits had dropped by nearly $600 million between March 28 and April 24, and it needed to secure a $2 billion lifeline to mitigate the impact.

It did s ec ure one in t he end, f r om a s yndicate of lenders including the Healthcare of Ontario Pension Plan — but at an onerous rate that analysts pegged at a 22.5 per cent effective interest rate for the first $1-billion.

To that end, Home Capital has said the terms of the loan agreement would have a “material impact on earnings” and it would not be able to meet its previously announced financial targets.

It has retained RBC Capital Markets and BMO Capital Markets to “advise on further financing and strategic options” as analysts said a runoff or sale of the company was a growing possibilit­y.

“We are taking important steps to seek to stabilize the business, starting with the announceme­nt ( Thursday) of a new credit line,” said Kevin Smith, chairman of Home Capital’s board. “There is a great deal of value in Home’s business, and we provide a key service to an important segment of Canadian homebuyers. As rough as the past few days have been, we are very focused on getting this company back on track and doing everything we can to make that happen.”

A spokeswoma­n for the Office of the Superinten­dent of Financial Institutio­ns said in an email Thursday it “continues to watch the situation closely.”

Key f or Home Capital in t he coming weeks is whether it can continue to get savers to buy its broker GICs, which comprise some 70 per cent of its non-securitize­d funding.

“If the funding channel dries up, there is no other source of funding that can take its place,” said Rizvanovic, noting that 52 per cent of those GICs are due to mature in a year.

Either Home Capital maintains their funding, get purchased by a strategic buyer, or OSFI steps in to help liquidate it, he added.

All of this is despite the f act that the underlying mortgages in Home Capital’s book are thought to be strong, but overshadow­ed by the company’s governance issues, said Rizvanovic.

Alt hough t he week’s events were the result of Home Capital own governance issues, the Veritas analyst said he is “sad” to see it unfold.

“This is a long dated company, 30 years, and for them to potentiall­y go out this way is really, really unfortunat­e.”

For Cohodes, this week’s events feel like validation.

“I’m very impressed with myself, ” he said from California. “I have a huge fan base of people who sold the stock and or shorted the stock and got out of this trainwreck, and they’re very happy.”

 ?? PETER J. THOMPSON / NATIONAL POST ?? The Toronto offices of Home Capital Group at 145 King Street West in Toronto.
PETER J. THOMPSON / NATIONAL POST The Toronto offices of Home Capital Group at 145 King Street West in Toronto.

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