Home Capital investors are victims of Canadian real estate uncertainty: Don Pittis
If house prices continue to soar, subprime lender's assets are worth every penny and more
There are a lot of Home Capital investors looking for someone to blame.
Today when the company releases its delayed results, everyone will be going over those books with a fine-tooth comb, trying to divine whether the mortgage finance firm will survive and prosper — in which case it's a great buy — or if confidence in the company will continue to slump.
Today's results may not be definitive. It is likely they will just be one more piece of evidence in a battle involving investors and company managers over whether the business model for Canadian subprime lending is sound.
Comparison with U.S.
Interesting thread comparing to the collapse of Canada's #1 sub-prime mortgage lender Home Capital to US in 2007. <a href="https://twitter.com/hashtag/bcpoli?src=hash">#bcpoli</a> <a href="https://twitter.com/hashtag/vanpoli?src=hash">#vanpoli</a> <a href="https://twitter.com/hashtag/cdnpoli?src=hash">#cdnpoli</a> <a href="https://t.co/E8moVWMGtI">https://t.co/E8moVWMGtI</a>—@Lidsville
As usual, when a company — especially a deposit-taking institution of the kind where Home Capital raised its mortgage cash — is threatened with collapse, there is more than one reason.
Home Capital shareholders and their advocates have pointed fingers at short sellers who made public bets that the company's shares would crash. Others have blamed the Ontario Securities Commission, the regulator that declared the company had failed to properly inform its investors.
Boom or bust
And in the background are highly publicized stories of a Canadian property bubble inflating rapidly as it repeatedly soars to irrational levels.
It was bad luck for Home Capital that its crisis came just after a series of moves by federal and provincial governments to bring the residential real estate market under control in a way that some feared could overshoot, leading to a long-predicted market correction.
Many of us in the media have been warning of an overheated Canadian property market for so long that homeowners, potential buyers and companies profiting from real estate have every reason to be skeptical.
In the case of Home Capital, the OSC announcement in April that it was going to proceed against the company may have been the trigger, but like the shooting of the Archduke Ferdinand, blamed for the start of the First World War, there was a lot more going on.
Vocal short sellers have been criticizing the company for years. Of course the opinions of short sellers, who borrow shares and sell them with the expectation they can buy the shares back at a lower price, must always be taken with a grain of salt. For them, success in driving down shares is money in the bank.
Two more factors helped make the mortgage lender unstable. One was that it raised its mortgage funding from depositors through its banking division. The other is the curse of all lenders suffering from a run.
The rules outlined by Office of the Superintendent of Financial Institutions are complicated, but lenders must maintain their Tier 1 capital, which depends on deposits and equity.
Rival MCAP is the unnamed buyer of Home Capital mortgages, sources tell <a href="https://twitter.com/willis_andrew">@willis_andrew</a> <a href="https://t.co/bzINtfqWLV">https://t.co/bzINtfqWLV</a> <a href="https://twitter.com/hashtag/cdnecon?src=hash">#cdnecon</a>—@wicary
Underlying Home Capital's decline is its position at the bottom end of the mortgage market.
Canadians are notoriously good at paying off their mortgages. However, by definition subprime lenders, who give out mortgages to people the big banks have rejected, would be first to suffer in a property downturn.
So far there are no obvious signs of a crash in Canadian real estate. A telephone poll from the business news service Bloomberg and Nanos Research says a majority of Canadians believe prices will continue to go up.
If the Canadian property market continues to rise, the portfolio of mortgages held by Home Capital is as sound as it was two months ago.
So long as today's results contain no surprises and providing Home Capital can stop the hemorrhaging of its capital, it can live to fight again.
But if the company continues to weaken and fail, leaving its borrowers without an alternative source of money when their mortgages come due, Home Capital could itself become the trigger of larger real estate decline.
Follow Don on Twitter @don_pittis
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