Alternative Mortgage Lender in Trouble

Home is where the house is, in a manor of speaking. 😀 Real estate is a popular topic, especially when a large player in the subprime lending market is under fire. Home Capital Group Inc. recently disclosed it has secured a large $2 billion loan, but is effectively paying 15% to 22% interest on it.  One explanation is that Home Capital is facing a liquidity crisis, and is desperate for funding. “Basically they blew up the income statement in order to save the balance sheet,” says David Baskin of Baskin Wealth Management. This is not a good place for any company to be in. Home Capital went from a $1.9 billion company a few months ago, to a market cap of just under $700 million today. 🙁

Surprisingly Home Capital (TSE:HCG) was still considered investment grade a few months ago. But in light of this new event, I wouldn’t be surprised if it gets downgraded soon to CCC or some other junk status by credit rating agencies.

Home Capital Group Inc.’s shares plunged about 70% last month after disclosing its financial situation. On the plus side, Home Capital stock is currently paying a juicy 13% dividend yield. 🙂 But with promising returns like that, there must be a substantial amount of risk. I think its dividend will be cut within the next quarter or so. I certainly don’t want to invest in HCG at this time.

But it’s important to separate the company from the assets it holds. Home Capital’s downfall is not related to its loan book. The company is in trouble for improper disclosure and possibly committing fraud. But the delinquency rate on Home Capital’s loans is only 0.25%, which is even “lower than the major Canadian banks,” noticed Marcus Tzaferis, a Toronto-based mortgage broker with MorCan Direct.

Worries about the general subprime lending market caused competitor Equitable Group (TSE:EQB) to fall 47% in April. This is a worrying trend. My public mortgage investment corporations (MICs) decreased in value as well, although by a much smaller amount of 5% last month. Furthermore, large Canadian banks are down about 3%. But I think this is temporary. Both MICs and the big 5 banks should bounce back by next month because I don’t see any real problems in the lending market itself.

At the end of the day here are some things to take away from this story.

  • Credit rating agencies are still as unreliable as they were in 2008. Don’t count on them to warn us of the next major market downturn.
  • Don’t concentrate too much on one asset class. If putting money into the mortgage industry, choose a wide range of banks, MICs, and other financial companies. Not just one type.
  • Mortgage lending companies may be in trouble, but relatively low delinquencies across various interest rate ranges suggest Canadians can still afford to borrow money for real estate and pay their debts on time. 🙂
  • Just because a dividend yield is attractive, doesn’t mean it is sustainable.
  • If you have a mortgage, consider paying it down as slowly as possible. This increases savings so you can speed up investing. This Reddit discussion goes into more detail. It looks like more and more people are starting to realize what I’ve been saying for years; when interest rates are low, invest, don’t pay down debt. And if we take this concept one step further then it turns into taking on more debt to invest, which is also known as leverage. 🙂


Random Useless Fact:

Online ads are getting smarter.

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John R
John R
05/01/2017 7:24 am

Nice analysis Liquid, the stock is waffling even with the $2 billion credit line

Purely on a stock play – would you buy HCG or short it?

My two cents worth on HCG (at the time of this post), I would buy 1000 shares at it’s current price (in the $6.50 -$6.70 range)then immediately sell the Oct 2017 $3 covered call deep in the money.

I pocket the difference between the buy price & the option price + any premium. My money at risk is $3, yet I picked up a ($$0.70 – $0.80) premium. $0.80/$3 = 25% ish ROI & the sooner the option gets called the better

Plus maybe the next dividend in May & August if there is one

The downside is on the basis the option at $3 – $0.80 in option premium, the real money at risk is $2.20. If the stock totally tanks to less than $2.20 I will have lost money

05/01/2017 4:48 pm

Alternative lenders are likely to be fine if they’re in smaller markets with decent LTV. When you go higher than 80% LTV you get into trouble with any housing market corrections.

05/02/2017 4:45 am

“Credit rating agencies are still as unreliable as they were in 2008. Don’t count on them to warn us of the next major market downturn.”

Couldn’t agree more. They are great at telling you where a company has been not where it’s going.

John R
John R
05/02/2017 8:10 am

These days I do maybe one trade a year. I hold only two positions in my TFSA, none at present in my non-registered investment account

On the analysts, yes it’s always about the past & not so much the future. Few will speculate the next 12 – 36 months and get it right.

I don’t follow a particular financial website, I found what the guys way down in Sydney Australia put out as ‘information’ is as good as it gets

It’s free, it requires a sign up before accessing the research

I looked at what they said about HCG, they covered the past as well as putting out the 3 year forward looking projections

Paul N
Paul N
05/02/2017 2:30 pm

Do you remember when the credit agencies “tried” to do their job after the crash of 08 and they were attacked and ostracized for doing so by the Obama government and their supporters/enablers? Do you really blame them for “sunny day” ratings?

For some humor :

Wife: Grow up…… (fill in anything) here.

Me : I really don’t care what you say, gents go MGTOW – there is nothing better.

05/03/2017 6:03 pm

what I haven’t seen in all the coverage is a reason for the run on their deposit accounts.

did they drop interest rates? did somebody else raise rates? was there some “scare news” (not that I saw)

anybody here know?

I mean wtf.
they offer interest bearing deposit accounts.
offer 5% promotionally and good luck keeping up with the flood of incoming money. why borrow $2b at unfavourable terms?

05/05/2017 2:05 pm
Reply to  ross

There was plenty of scary news that broke faith in the company. Sacking the CEO with no warning or replacement in place after less than a year on the job in the midst of an OSC investigation was probably the one that primed the run. Esp. when he was replaced by someone with little banking experience — but who did have experience in winding down troubled companies and working for a trust company swallowed up by a big bank. So wealth managers and brokers stopped letting clients place more than the $100k CDIC limit with them for fear of increased risks.

John R
John R
05/07/2017 2:02 pm

At the time of this post who the heck knows what next will happen next week with HCG

On the HCG technicals, I would likely sell the long October or December $3 PUT, buy the stock then sell the long October or December $3 call deep in the money (DITM).

What’s the downside, it’s basically getting the next two or three dividends with the stock dropping below $1.50 approx to lose money before clearing the positions*

The upside the stock stays above $3, the option contract gets called, a pick up of two or three dividends + the PUT premium, + the premium on the $3 call option. All in approx $1.50/share on money at risk 50% ROI

John R
John R
05/08/2017 3:12 am
Reply to  John R

from Canada Newswire this morning “suspends quarterly dividend”. Will the stock tank further or pop as a result?

“Canada NewsWire

TORONTO, May 8, 2017

TORONTO, May 8, 2017 /CNW/ – Home Capital Group Inc. (“The Company” TSX: HCG) today announced that it has drawn down a total of $1.4 billion from its $2 billion credit line, the terms of which were announced by the Company on April 27, 2017.

The Company and its advisers continue to work towards seeking lower cost sustainable funding solutions and to evaluate strategic alternatives to solidify and strengthen its successful mortgage origination platform.

In addition, the Company announced the suspension of its quarterly dividend to prudently manage liquidity.

The Company’s existing mortgage portfolio continues to perform well. The Company’s liquid assets stood at $1.160 billion as of end of day May 5, 2017.”

John R
John R
05/09/2017 11:19 am

what a nice turnaround. Now it’s the wait & see report on May 11