What the Fall of Home Capital (Doesn't) Mean

The Fall of Home Capital and What it (Doesn’t) Mean for Canada’s Housing Market

Recently, a few people have asked me what the implications are of the recent 60% decline in Home Capital’s stock price, so I thought I would make a quick post.

In short, it is not a concern for the broader housing market.

Home Capital’s business model is sufficiently different from the vast majority of mortgage lenders, it doesn’t owe money all over town, and its clients are generally in low-risk markets.

This means that a contagion effect, where investors pull money from other, similar, lenders, thus reducing available capital and limiting new mortgages, is highly unlikely. Furthermore, Home Capital’s clients (should the firm become insolvent, which is not necessarily going to happen) can most likely get their mortgages renewed elsewhere.

What is Home Capital (Home Trust)

Home Capital, operating through Home Trust, is a trust company that offers mortgages, deposit services and credit cards across Canada.

They have about $26 billion in loans, with $16 billion in mortgages. I will focus on their mortgage business.

They focus on “sub-prime” mortgages in prime markets:

  • Their typical client is unable to get a standard mortgage from a bank due to income, credit, or employment status (self-employed)
  • Their mortgages are low LTV – they don’t give mortgages with an LTV over 85%
  • They focus on single-detached houses in low-risk areas (77% of their mortgage portfolio is in Ontario. Some is in Alberta but half of it is insured)
  • 80% of their mortgage portfolio is uninsured

What Caused the Decline in Home Capital’s Stock Price?

The company was caught fudging numbers in order to get some of their clients approved. Then the Ontario Securities Commission alleged that executives misled shareholders about this, which violates securities law.

When this was announced, investors began withdrawing funds from Home Capital, reducing their available capital and hampering their ability to issue new mortgages. When Home Capital announced this, other investors got spooked, withdrawing more funds and creating a run on the trust company.

Home Capital then took out a $2 billion dollar line of credit to ensure access to capital, which spooked the markets and sent share prices tumbling by 60%.

What Happens Now?

The $2 billion line of credit buys Home Capital time to either right the ship or sell off its assets in an orderly manner.

They have $16 billion in outstanding mortgages that are concentrated in single-detached homes in low-risk areas with low LTVs. While it shouldn’t be hard to find parties willing to take on those mortgages, it remains to be seen what terms the borrowers will be offered upon renewal.

If Home Capital does go under it may become more difficult for its prospective clients to find a mortgage, putting a squeeze on that segment of the market. However, I suspect that competitors will be happy to step in and fill the void.

Why Should You Be Unconcerned?

There are a few reasons why I don’t believe this will have a significant impact on housing markets:

1 – Home Capital Was Financially Sound Before This

Home Capital’s lending operations got them in hot water but the clients they were lending to were generally paying back their debt without issue, so there isn’t a lot of “bad debt” on their balance sheets.

2 – They Don’t Owe Money All Over Town

Similar to the last point, their books are in good standing, meaning that, even if they did suddenly go out of business, that wouldn’t cause a cascade effect, damaging the balance sheets of companies they owe money to.

3 – Home Capital is a Drop in the Bucket

Home Capital’s $16 billion mortgage portfolio is only about 1% of the market, so the potential loss of its mortgage issuances won’t cause a massive disruption and would not be enough to cause any destabilization in and of itself.

4 - Home Capital is Not Representative of Most Mortgage Lending

Home Capital’s business operations are not representative of most mortgage lending. It operates in a small, but growing niche of the market, focusing on B-lending. So their problems are not representative of the market as a whole.

5 – The Problems of Home Capital are not Endemic of B-Lending

Most B-lending focuses on clients that used to qualify for traditional mortgages but no longer do because of increased restrictions.

These clients are a far cry from the sub-prime lending clients that are now synonymous with the U.S. housing crash.

6 – Competitors Will Fill the Void

Home Capital represents a small part of the market that has grown as a result of tightening underwriting practices that have pushed some prospective homebuyers out of the purview of traditional banks.

These mortgages are still safe investments and, unless the Federal Government cracks down on alternative mortgage lenders, there should be ample funds available to fill the void left by Home Capital in the event of its demise.

Conclusion

Things will be fine.

Home Capital's decline is its own fault and is not the result of a malfunctioning market and is no reason to believe that this will spread to other lenders.