Saskatoon StarPhoenix


How mortgage lender Home Capital went from resilient market darling to the brink


As Home Capital Group Inc. was having its worst week ever, at least one person in the investment world was smiling.

Marc Cohodes, a short seller who has been described as a “scourge of Wall Street” has for more than three years bet on the implosion of the Toronto-based alternativ­e mortgage lender. He’s been one of the company’s most vocal critics, fanning the flames of concern that have lingered since Home Capital acknowledg­ed discoverin­g problems in its broker channels in 2015.

And this week’s turmoil was his turn for a victory lap.

“HCG is finished.. Thanks for playing” he tweeted from his account @alderlanee­ggs on Wednesday, the day Home Capital’s shares fell the most on record, a whopping 64.9 per cent.

While Cohodes’ declaratio­n may be premature, there has been much for him to relish on the Home Capital front in recent days.

Since the Ontario Securities Commission filed a statement of allegation­s against the company on April 19, the company’s founder and former CEO, Gerald Soloway, has agreed to step down from the board of directors; there has been a partial run on its funding, with clients pulling out nearly $1 billion of demand deposits from its subsidiary this week — with $290 million withdrawn on Thursday alone; and it has been forced to take on a pricey $2-billion credit line as an emergency backstop.

Questions now linger about the firm’s ability to fund its operations, and there’s speculatio­n that a sale or government interventi­on could be possible.

Given all the turmoil, it is hard to believe Home Capital was once a darling of the Toronto stock market. It came from humble beginnings as Home Savings Loan Corp., a St. Catharines-based company that Soloway, Home Capital’s founder, bought in 1987.

At the time, it had just 12 employees, with $51 million in assets and $3 million in equity. By 1990, Home Capital started focusing exclusivel­y on residentia­l lending.

Along with its wholly owned subsidiary, Home Trust Inc., Home Capital aimed to provide mortgages to those who didn’t qualify for traditiona­l bank loans — to borrowers were self-employed or had once been bankrupt, or had no credit history.

“It was reporting consistent growth, always meeting their numbers, and 20-plus ROE (return on equity) for many years,” said Mike Rizvanovic, an analyst with Veritas Investment Research in Toronto. “It was able to see very rapid growth.”

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 banks’ then average of 17.6 per cent.

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 it continued to grow. Amid 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.

It wasn’t until November 2014, when Home Capital’s quarterly earnings fell short of analyst forecasts that Cohodes 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 terminatin­g 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 irregulari­ties 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.

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.”

It wasn’t until July 2015 that the general public heard something was amiss. Home Capital publicly announced on July 10 that a 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.

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 investigat­ion 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.

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. 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, 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 nine per cent.

The OSC filed formal allegation­s against the company on April 19 and Home Capital shares continued to fall. None of the allegation­s have been proven, and the company has vowed to defend its approach to disclosure to the OSC.

This week, the fallout 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 secure one in the end, from a syndicate of lenders including the Healthcare of Ontario Pension Plan at an onerous rate.

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.

The Office of the Superinten­dent of Financial Institutio­ns said it “continues to watch the situation closely.”

It was reporting consistent growth, always meeting their numbers, and 20-plus ROE (return on equity) for many years.

 ?? PETER J. THOMPSON ?? Home Capital faces turmoil over its future after a week of setbacks that included its shares’ dive, sparking speculatio­n of a potential sale or government interventi­on.
PETER J. THOMPSON Home Capital faces turmoil over its future after a week of setbacks that included its shares’ dive, sparking speculatio­n of a potential sale or government interventi­on.

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