Some housing bears anticipate that low mortgage rates will fuel a short-lived spring revival.Moe Doiron/The Globe and Mail
Home Capital Group Inc. is a divisive stock.
The funny thing is, both sides of the debate may be right. It just depends on your time horizon.
On one side, critics of the Canadian housing market say the company is vulnerable to a selloff. Here you have Steven Eisman, a money manager made famous in the book "the Big Short" for betting against U.S. housing at just the right time.
He thinks it's a candidate for a short, because it is a monoline play on the Canadian housing market. If the market tanks, he told investors at a conference Wednesday that Home Capital could have "serious problems." One of the red flags here is that Home Capital tends to serve customers who might not otherwise qualify for a bank loan because they are self-employed, have had credit problems in the past, and borrowers who have home equity but can't prove income or don't have credit history.
Superficially, it looks like one of those non-bank lenders that got in so much trouble in the U.S.
On the other side are believers like Jason Donville of Donville Kent Asset Management, a top performing hedge fund that has made a name for itself finding overlooked small financial companies. He recently told the Globe that the worries about the company are overstated. The bulls say it's profitable, cheap and its borrowers are better qualified than people realize. Those borrowers? They pay their bills. Total provisions for losses as a percentage of gross loans were 0.11 per cent last quarter.
What could make the shorts right?
If housing does roll over, Home Capital's growth will be seriously hit. Mortgage originations will be a challenge, and if the company holds the line on credit quality, growth will vanish.
However, that's a different thing than expecting the company to run into "serious problems" of the sort that we saw in the U.S., where lenders outright folded.
The two big risks would be liquidity risk and credit risk – i.e. Home Capital's ability to keep funding its mortgage portfolio and the risk that so many mortgages go bad that the company runs out of capital.
On the credit risk side, Home Capital's portfolio has two kinds of protection. There's mortgage insurance on about half of the residential mortgages in Home Capital's $18.5-billion in loans under administration. Unless you believe that the government, which backs mortgage insurance, will hang institutions out to dry, the losses in that portfolio ought to be limited.
The other half of the residential mortgage portfolio is uninsured. There, the protection against a loss on a loan gone bad is Home Capital's ability to repossess the house and sell it for a value that covers the balance on the loan.
Each loan is different, of course, but in the main there is a lot of equity in front of the loans.
The loan to value ratio for all the loans in the uninsured portfolio is 73 per cent. Most of Home Capital's loans are in Ontario, home to the hot housing market of Toronto. For the province as a whole, the LTV is 71 per cent.
Worried about Vancouver? The LTV in British Columbia is over 90 per cent, but loans to borrowers in the province represent only 4.6 per cent of Home Capital's outstanding uninsured mortgages.
And high-rise condos, the really concerning part of the housing market, represent less than 7 per cent of all mortgages for Home Capital. Forty-four per cent of those are insured, and the LTV is 70 per cent.
To be sure, that is more risk than on a bank's balance sheets. In some recent disclosures, the big banks laid out LTVs for uninsured mortgages on residences in the range of 47 per cent to 59 per cent. In a housing downturn, Home Capital's loans have less cushion. Good reason to pick it if you are a short.
The counterargument is that Home Capital's capital ratios are well beyond what a bank would be expected to carry under Basel requirements. (Though that requires an investor to be comfortable with the risk weightings of the assets. One interesting question about Canada is whether our risk weightings are prudent enough.)
The reality remains that to really cut the legs out from under Home Capital, you would require some sort of catalyst, either a surge in joblessness or high interest rates, that mean people can't pay their mortgages. Then you would need housing prices to fall significantly, perhaps as much as 30 per cent, so that Home Capital would not have the ability to recover loans gone bad by seizing and selling homes.
Within the realm of possibility? Sure, but few are predicting that kind of mess.
The other big risk is liquidity. Could a disruption in markets leave the company in a situation where it cannot fund its loans?
The company has among the safest sources of funds – savers who have bought term deposits.
Home Capital does not use the wholesale market to get money, so there are no big counterparties pull lines of credit.
The company has basically funded all its unsecuritized assets on a one-to-one basis with deposits, 99 per cent of which are fixed term. No overnight liquidity crisis will sink the company.
So, short of a housing apocalypse in Canada, the big risk to the business is that growth disappears, and the company struggles to make returns through a downturn, not that it fails.
In fact, the biggest risk is likely headline risk. Investors looking for a way to make a bearish bet on the Canadian housing market don't have many options when it comes to a pure play on housing. Home Capital is going to get a lot of attention as Canada's housing market does.
If the housing market does really start to crack, the stock will feel it, likely all out of proportion to the actual risk to the business.
So the bears may well be right, even if it is self-fulfilling.
However, that's a different thing from a real existential risk. The numbers suggest that there is a fair bit of prudence built into Home Capital.
Given that, long-term holders may be comfortable living through a sell-off driven by housing fears, so long as the company's viability doesn't come into real question. Someone like Mr. Donville may even use a headline-driven decline to accumulate more.
(Boyd Erman is a Globe and Mail Reporter & Streetwise Columnist.)
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