The push to contain Home Capital’s free fall

Finance minister spoke to heads of Canada’s largest commercial lenders

As Home Capital Group’s shares were in free fall last week, the fight to stop the bleeding at the Canadian mortgage lender had already begun.

It was late Tuesday, Ottawa time, when federal Finance Minister Bill Morneau received his first briefing from department officials just as he was boarding a plane in Beijing to head home.

Home Capital had been reeling for a week after the Ontario Securities Commission accused the company of misleading investors over fraudulent mortgages. That was sparking a run on deposits, forcing the company to take on a $2-billion emergency credit line at an effective interest rate of 22.5 per cent on funds drawn so far.

On Wednesday, April 26, Home Capital’s shares dropped 60 per cent by lunchtime as investors bet the onerous terms of the loan would squeeze the company. There was also contagion risk. Canada’s major banks saw their shares slump, while Equitable Group, a rival of Home Capital, plunged by almost a third.

Morneau landed in Ottawa Wednesday night, calling his departmental officials as he got off the plane for the latest information, according to people familiar with the discussions. He later spoke with Jeremy Rudin, head of Canada’s Office of the Superintendent of Financial Institutions, who is responsible for regulating what the World Economic Forum has called the “soundest” banking system.

On Thursday, Morneau’s office pledged his support for Rudin’s OSFI and the banking sector.

“Our government has full confidence” in OSFI to “manage the situation,” Morneau spokesperson Annie Donolo said.

The pledge wasn’t enough to calm investors. While Home Capital’s stock recovered on Thursday on speculation a buyer for the company might emerge, the deposit run continued, totalling $892 million over three days to close the week. What’s more, the onerous terms of the high-interest lifeline, later revealed to be from Healthcare of Ontario Pension Plan, resonated beyond the company.

“We looked and felt, what on earth are they doing?” Equitable CEO Andrew Moor said. “We thought that might cause issues of confidence in the market, frankly, and so immediately we started reaching out to our bankers.”

Equitable started to face a rash of withdrawals, too, losing about $75 million daily between Wednesday and Friday — even though the Canada Deposit Insurance Corporation provides a safety net by guaranteeing deposits of up to $100,000.

OSFI, meanwhile, put out requests to lenders asking for updates to get a handle on the damage, though spokesperson Annik Faucher called it part of “ongoing supervisory activities.” In a separate statement, she acknowledged the situation has increased “our level of activity and vigilance.”

Canada’s alternative lenders, such as Home Capital and Equitable, typically offer mortgages to borrowers who have trouble getting home loans from big banks because they lack a credit history, such as the self-employed, new immigrants and small-business owners.

Just as Moor was reaching out to banks, Morneau was doing the same. On the weekend, he spoke with heads of the biggest commercial lenders to discuss Home Capital. While Morneau doesn’t consider Home Capital a systemic problem, he was focused on assessing the risk its woes could spread to other alternative lenders, according to people familiar with the talks.

A core Morneau message over the past week has been to ensure market stability.

By Sunday night, the commercial banks — including Toronto-Dominion Bank and Bank of Nova Scotia — agreed to a $2-billion loan for Equitable at a rate of about 1.6 per cent to 1.7 per cent.

It was Monday that Morneau issued his first public comments.

“Financial stability and security are the backbone of a strong and resilient economy,” he said. “What I’ve seen over the last few days is proof the system is working as it should.”

The question now is what to do next with Home Capital. While it only accounts for one per cent of Canada’s $1.4-trillion mortgage market, it still has almost $18 billion in mortgages. If withdrawals continue, it could be unable to renew them or bring in new business. That could deprive potential home buyers of credit, adding to a slowdown that’s already showing signs of developing in Toronto and Vancouver.

“This could be just an isolated situation and that’s the higher-probability outcome at this point, but you cannot ignore the risk that this can get messy,” said Aubrey Basdeo, head of Canadian fixed income at BlackRock.