Canada

One of Canada’s Largest Mortgage Lenders Just Imploded, Here’s What Happened

One of Canada’s Largest Mortgage Lenders Just Imploded, Here’s What Happened

One of Canada’s largest mortgage lenders just imploded, and it may have serious consequences for Toronto real estate. Home Capital Group, a publicly traded company that engages in non-prime (a.k.a. subprime) lending, saw its stock drop over 60% in a single day. The reason? They’re facing a liquidity crunch, as their capital for subprime mortgages dried up very quickly. This could be the start of a broader trend of investors derisking, and it may kill a significant segment of high-leverage buyers.

Home Capital’s Massive Drop

The company’s stock has been on a steady slide for the past couple of years. It reached a peak of $55.24 a share in August 2014, before tumbling all the way down to $5.99 a share as of yesterday’s close. In the process, Home Capital Group has shed an estimated $2.6 billion in market cap, and is now worth just a little over $400 million. It’s been a rough couple of years.

Problems at the company first appeared in 2013. That was year that Steve Eisman, yeah – the dude from The Big Short, presented his short thesis on the company’s subprime operations. Then last year, former hedge-fund manager/noted short-seller Marc Cohodes called out the company for not cracking down hard enough on known fraud. Sometime this year regulators finally caught up with the issues, and called them out too. Most people thought they were overselling problems at the company…until yesterday.

Home Capital Group Takes Out A Credit Line of $2 Billion

Shortly before the market opened, Home Capital Group announced it had entered a non-binding agreement for a $2 billion credit line. Turns out in the past 30 days, $591 million in cash was withdrawn from high interest savings accounts leaving them short on capital. This essentially creates a textbook example of a run – which is when a bank sees customers withdraw money all at once. This leaves the bank short on operating capital, forcing them to seek emergency credit lines, have a fire-sale of assets, or both.

In a twist of irony Home Capital Group, a subprime lender themselves, received a credit line with fairly predatory terms. Who supplied the credit is still hush, hush, but they did publish the terms of the deal. Their $2 billion line is subject to an immediate draw of $1 billion, and they will need to pay a $100 million commitment fee. The interest rate on the outstanding credit is 10%, and the “standby fee” for undrawn funds is 2.5%. At those rates, it’s pretty difficult to imagine them making substantial money…considering the mortgage lender is paying interest almost 3 times the rate of an average mortgage.

Broader Consequences For The Market

I know what you’re thinking, who gives a crap if one bank is imploding before our eyes? However, this might be the catalyst that sends our multi-decade bubble into a headspin. Canadians have become increasingly addicted to sub-prime mortgage borrowing, and it has become a major driver of the Toronto housing market – Home Capital Group’s home base. As the lender faces a tougher environment, less loans for subprime borrowers will be available. If Toronto loses a significant number of buyers because they can no longer obtain loans, the market is going to feel that impact.

The circumstances Home Capital Group are entering sounds a lot like the situation with New Century Bank in 2007. New Century was the second largest subprime lender in the US (and smaller than Home Capital Group at peak), and faced a sudden liquidity crunch. No move they could make would help them out, and they eventually filed for bankruptcy in April of 2007. This was the first domino that would set off the Great Recession. But that can’t happen in Canada, right?

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16 Comments

  • Reply
    Michael 7 months ago

    Baskin Wealth just liquidated their position. That’s the last major vocal supported as far as I know. It’s going to be rough to turn around investor sentiment at this point.

  • Reply
    David Simpson 7 months ago

    I think HCG will recover. They have a strong GIC backing for their assets.

    • Reply
      Simon C. 7 months ago

      More than 50% of their GICs are due to mature in the next 12 months. Good luck trying to convince anyone to buy into their new GICs, since fixed income investors aren’t they type of people that like companies under investigation by the OSC.

    • Reply
      Alice 7 months ago

      Anyone that thinks this company is recovering does not understand the part with the loan. This is a high-interest loan, they can’t make money on. They likely took it to restructure the company. You’ve got to be okay with a lot of portfolio volatility to buy into this which a company is restructuring at the height of the Canadian real estate market.

      I hope they survive the restructuring because I like the interim CEO, and it would be crappy to have her walk the glass cliff. However, it’s not looking great.

      • Reply
        Rob 7 months ago

        I agree, it’s not looking good for them. With a huge high interest loan, stocks falling and people losing faith in them it’ll be a struggle to turn it around before a total collapse.

    • Reply
      Theopholus 7 months ago

      No, they don’t!

    • Reply
      Vangel 7 months ago

      GICs are short-term instruments. Unless HGC has matched their mortgages with their financing, it could have problems. That said, it might be a blessing as the company could call in its maturing mortgages and get back the capital it lent out while the market is still hot. If management plays it right, it could be a survivor by avoiding the consequences when the market corrects.

  • Reply
    Steven 7 months ago

    If you stuck with this company through fraud allegations, a CEO departing, the CFO being removed, and an OSC investigation…you deserved yesterday’s drop. Sorry….but not really.

  • Reply
    No One 7 months ago

    HCG may be a drop in the bucket in terms of overall mortgages but if it does default what will happen to all those that have mortgages obtained using fake income? As I understand it HCG wrote over $2billion of those.

  • Reply
    Paul 7 months ago

    That’s not a good a situation for the Canadian housing market 2 billion of second mortgage dept is = to about 3000 homes at 700k that means a lot more inventory prices will drop, I think we are in for a 35% drop its coming shorty cash out while you still can.

  • Reply
    Terry Khan 7 months ago

    This is foreshadowing what is to come. Canada has 1.4trillion in outstanding mortgages + 200billion Home Equity loans. This will turn out very nasty, 1.1trillion are from the big banks, 300 billion are from alternative lenders like HCG. My guess is Equitable Group, and Genworth will both collapse in similar fashion. The Canadian big banks have built up terrible lending practices, issuing far too many subprime loans. CIBC is giving out first mtgs, and HELOCs @ 65% house value, both with “no income verification”, and are giving 1.5% mtg teaser rates for 9 months. Essentially NINJA loans CAD style, we saw how that worked out south of the boarder. The 200 billion home equity loans is garbage, people do very fancy renos, buying high end cars, and blowing it on vacations. No risk of default on any of this stuff, cause house price in Canada only go up, right?

  • Reply
    Theopholus 7 months ago

    “Most people thought they were overselling problems at the company…until yesterday.”

    LOL, just like 2008. New movie: the big Canadian short.

  • Reply
    Safe As Houses 7 months ago

    Good reporting here however it would be better with less bias and opinion. The comparison to the US housing crisis in 2007 is really not relevant. This situation is a loss of confidence in one purportedly corrupt lender and it’s business operations, not a trial on the Canadian housing market.

    The question I have is what % of HCG’s existing loans are in good standing and reasonably anticipated to be paid off at maturity? That’s the most important part of this equation as the book value of their loan portfolio and cash (pre HOOPP announcement) minus liabilities approximates to 3x the value of the share price.

    So basically either the loans are severely impaired and they’re not reporting it (are there any obvious cracks in the housing market where they are exposed?) or the share incredibly undervalued. The emergency loan should cover further depositor redemptions while they liquiditate the loan portfolio.

  • Reply
    Justin Thyme 7 months ago

    There is no real impending disaster warning flags yet.

    What matters now is how they restructure their debt. Essentially, the GIC’s that come due are the problem – billions of dollars. The run on deposits is small chump change compared to this. If they are not renewed, Home has to come up with the money to pay them out. If they call in mortgages, the mortgagees will be scrambling to find new mortgages – not a given that they will get them, but the money is available if the rates go high enough. Otherwise, lots of fire-sale opportunities as they put them on the market. If Home does not pay out on the GIC’s, they are essentially heading for receivership.

    The big problem in the States was that the sub-prime mortgages were re-sold as paper backed securities, in order to come up with the money to re-finance and continue what was essentially a ponzi scheme. Home will probably put its mortgage portfolio up for sale, to try to stay afloat. This is the domino effect that compounded the problem, and that brought other financial institutions into the fold – the fact that these sub-prime mortgages were essentially worthless.

    If this is just limited to Home, the damage is manageable by other players. Lots of money around to fill the gap, but mortgagees can expect higher ‘ransom’ rates. If these mortgagees have little equity, and cold feet, they may just walk away. But if no one else buys the paper, only Home is affected.

    Still enough demand that the foreclosed homes can be sold in a normal market. However, if too many walk away at one time, and the houses are sold at typically lower liquidation prices, it could ripple through regular sale prices. It could be a good time to pick up fire-sale bargains.

  • Reply
    Warren Buffett's Berkshire Makes Home Capital Group An Offer They Can’t Refuse | Better Dwelling 5 months ago

    […] of Wall Street must be getting ready to party like it’s 1999. Home Capital Group (HCG), the mortgage lender that’s had a rough year, struck a deal to sell a significant stake to a division of Warren Buffett’s Berkshire […]

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