National Post (National Edition)
On the edge of the housing bubble.
Home Capital is used to critics who say it’s vulnerable to a housing pop. Now the skeptics have other concerns
For the short sellers (and there are many) betting against Canada’s uncomfortably hot housing market, and specifically, the company seen as most exposed to it, Home Cap
ital Group Inc., it was a gratifying week.
Short positions in the company shot up, and the stock dove 19 per cent Monday, after the company revealed that new mortgages were much lower than expected in the second quarter — after an already weak first quarter. But that wasn’t the end of the unexpected news. Home Capital also announced it had cut ties with a number of its broker partners — third-party dealmakers — after their practices were deemed as not being up to Home Capital’s standards.
If Canada’s housing market is too overvalued, as observers from the Bank of Canada to the IMF have maintained, with Home Capital specializing in lending to clients who are often turned away by traditional banks — because of a rough credit history, or a lack of one, or because they’re self employed — the company is seen as highly vulnerable to the first slip in market stability. The piling on of bears after this week’s announcement may have been investors seeing cracks in the housing market. But it could also be some are worried about those substandard broker partners.
Multiple sources familiar with the company and its partners suggested this was no meagre number of brokers: They says hundreds of them were cut off, representing multiple firms. They were primarily based in Ontario and instances of improper mortgage documentation were discovered as part of an audit.
One result is, of course, fewer people bringing deals into Home Capital, which will not be helpful in getting revenue back on track. Another possible result could be investors wondering how many mortgages already backed by Home Capital were sold that weren’t up to snuff — and how deep these problems became before they were noticed.
Gerald Soloway, chief executive of Home Capital, said in an interview at his Toronto office that he is not worried about short sellers and their thesis that Home Capital is ground zero in a Canadian housing meltdown.
“I just profoundly disagree with the bets they are making,” he said. “We’re on the ground and we do not see the distress (in the Canadian market) they think is happening.”
Martin Reed, president of Home Capital, told the Financial Post that one of the brokers the company ended its relationship with was Torontobased Interfinance Mortgage Corp., a prominent regional brokerage that describes itself as holding “a large market share of subprime lending.”
However, when the Financial Post contacted Kiran Kaushal, president of Interfinance on Friday, she did not agree. “I am a broker, I don’t work with Home Capital” she said, and quickly ended the interview.
Home Capital, which operates through Home Trust Company, is one of Canada’s largest alternative mortgage lenders, with 40,000 uninsured mortgages on its books and an additional 25,000 insured mortgages, some of which are securitized and sold. The company has a footprint in Canada’s hottest housing markets, including cities in British Columbia, Alberta and Ontario.
Its focus on Canada’s biggest urban centres — it does little to no underwriting in rural Canada — has been a smart business decision as massive price gains and strong home-building centered in the country’s big cities has kept demand for mortgages strong.
Of course, all that frothy pricing has attracted those willing to bet the market is in a bubble ready to pop, and Home Capital’s direct exposure to riskier mortgages has made it a prime target. Data from financial information company Markit shows Home Capital has recently become the thirdmost shorted stock in Canada, with about 23.81 per cent of its free float shorted as of Thursday’s close.
Those bets were rewarded this week, with share prices tumbling nearly 25 per cent to $31.70 over the past five trading days. The stock is now significantly down from its high of $55.75 on Aug. 11, 2014.
Home Capital has been one of Canada’s fastest-growing companies in the past decade. It began humbly as Home Savings & Loan Corp., a St. Catharines-based company Soloway bought in 1987. Back then, it had just 12 employees, with $51 million in assets and $3 million in equity. It was a company where Soloway knew all his people personally. Today, it has more than 800 employees and $25 billion in assets.
It was Soloway’s more than two decades of experience as a real estate lawyer that gave him the spark to get into the alternative mortgage business. During his time as a lawyer, he was a branch solicitor for one of Canada’s major banks and said he noticed that it was becoming increasingly difficult for a growing market of selfemployed Canadians to get access to mortgages.
“I saw these individuals were very credit-worthy and they had good down payments and they had great capacity to service the loans, but they were getting turned down,” he said.
The business also catered to other segments of the market where borrowers faced trouble getting mortgages from the big chartered banks: recent immigrants and those with checkered credit history.
But just a few years after Soloway bought Home Savings, the Canadian housing market crashed. And the epi- centre then — as the short sellers sense is the case now — was Toronto, where a bubble fuelled by low unemployment and a massive immigrant influx had rapidly doubled prices in just a few years. When mortgage rates shot up to 14 per cent by 1990 and the economy entered recession shortly after, the market came tumbling down.
Today, there is talk of recession in the air, but interest rates could scarcely be much lower after the Bank of Canada’s quarter-point cut this week to a 0.5 per cent overnight lending rate, and the banks cut prime to as low as 2.7 per cent.
But Soloway said he learned a lot of lessons from that early meltdown.
“One has to be always prepared for a major adjustment in the mortgage market — it can happen without a lot of foresight or advanced warning,” he said. “Lending has to be done by asking: what if tomorrow is the start of a very serious recession?”
Last Friday’s announcement that Home Capital would sever ties with brokers revealed that the company sold just under $1.6 billion in new mortgages in the second quarter, a surprise to investors, considering most analysts expected a number well north of $2 billion. One short seller, who did not want to be quoted, said it set the short-seller community abuzz with talk of further downside in the stock.
Analyst Shubha Khan of National Bank notes that the brokers Home Capital cut ties with accounted for a significant portion of new mortgages, a number he pegs at about 15 per cent. He also said that mortgages from the ter- minated brokers “may be susceptible to higher loan losses” compared with the company’s current loan loss ratio of 0.07 per cent.
Reid said that while he is aware of the shorts targeting his company, Home Capital has not seen any uptick in arrears and furthermore, continues to attract a lot of positive interest from outside the country.
“We have a lot of long-term U.S. investors who are holders of the stock, and have been for many, many years,” he said. “They tend to do their homework and better understand the Canadian market — they understand better the differences between the Canadian market and the U.S. market, whereas the hedge funds tend not to do the due diligence. They don’t take the deeper dive and understand.”
In his office in Toronto, Soloway made it clear the company was taking steps to ensure that all the broker partners it does business with are up to the company’s standards.
“One of the things we’ve recently done is completely segregate, on mortgages, both the sales part and the underwriting part,” said Soloway. “Again, it’s a long-term method to ensure quality.”
Reid clarified that the changes were being implemented before the recent broker purge.
“We just rolled that out … for insured loans and we’re starting this month … on the other groups,” said Soloway. “There’s a constant evolving on how to get better and how to make the company safer, and still with the basic principle, how do we serve the group that brought us to where we are today.”
Still, those looking to cash in on expectations that loan losses are going to grow are positively swarming the company. Roughly 18 per cent of shares were being shorted before the announcement about the cancelled relationships, and by Friday that had grown to nearly one in four shares being shorted. Short positions have more than doubled since the stock hit its peak last year.
Of course, investors have bet against Canada’s seemingly unstoppable housing market before, and got it wrong. And Soloway is no stranger to defending Home Capital against the skeptics.
What’s changed this time is whether the skeptics are betting against Home Capital over more than just a housing bubble.
One has to be always prepared for a major adjustment in the market