What are homes & mortgages worth when push comes to shove?
Home Capital Group, Canada’s biggest “alternative” mortgage lender, is not a bank – which today is part of its problem because it cannot create money to lend out; it has to obtain it first by attracting deposits and borrowing money through other channels. Through its subsidiary, Home Trust, it specializes in high-profit mortgages to risky borrowers, with dented credit or unreliable incomes who don’t qualify for mortgage insurance and were turned down by the banks. This includes subprime borrowers.
Since revelations of liar loans – What, liar loans in Canada?! – surfaced in 2015, things have gone to heck. Now it’s experiencing a run on its deposits. Teetering at the abyss, it obtained a $2 billion bailout loan on Thursday. The terms are onerous. And on Friday, the crux of the deal emerged – the amount of mortgages it has to post as collateral. It’s a doozie.
It sheds some light on what insiders think mortgages and the homes that back them are worth when push comes to shove. A bone-chilling wake-up call for the Canadian housing and mortgage market.
This is when the whole construct started falling apart:
On July 15, 2015, Home Capital announced that originations of high-margin uninsured mortgages had plunged 16% and originations of lower-margin insured mortgages had plummeted 55%, and that it had axed an unspecified number of brokers. Shares plunged 25% in two days [Largest “Alternative” Mortgage Lender in Canada Denies “Systemic Problem” in Housing Market].
On July 30, 2015, it disclosed, upon the urging of the Ontario Securities Commission, the results of an investigation that had been going on secretly since September 2014 into “falsification of income information.” Liar loans. It suspended 45 mortgage brokers who’d together originated in 2014 nearly C$1 billion in residential mortgages, or 12.5% of its total [Liar Loans Pop up in Canada’s Magnificent Housing Bubble].
The scandal festered. Short sellers circled in formation.
On April 26, 2017, Home Capital announced that it’s experiencing a run on its deposits. As of the end of March, its subsidiary Home Trust sat on about C$2 billion in high-interest savings accounts (HISA) it is offering to regular savers. But these folks were pulling their money out, it said, and the pace of the run was accelerating.
It also disclosed that it was finalizing a $2 billion bailout loan from the Healthcare of Ontario Pension Plan (HOOPP) which has about $70 billion in assets. The loan would “have a material impact on earnings….” So an expensive loan.
Home Trust would pay a non-refundable commitment fee of $100 million; would be required to make an initial draw of $1 billion at an interest rate of 10%; and would pay a 2.5% standby fee on undrawn funds. So the initial $1 billion for the first 12 months would cost it $225 million in fees and interest, a juicy 22.5%! Once the credit line is fully utilized, the cost of the loan would drop to 15%.
Its shares collapsed by 65%.
On Friday, April 28, it announced that another C$290 million in deposits were yanked out on Thursday, after C$472 had been yanked out on Wednesday. Its HISA deposits were down to C$521 million, having plunged 75% since late March.
Home Trust still has about C$13 billion of Guaranteed Investment Certificates (GIC). They’re covered by deposit insurance up to C$100,000 per account. Since GICs have fixed terms, they’re harder to withdraw and have been stable. But many of them are maturing in the near future, and it will have trouble raising money by selling more GICs to cover those that are maturing.
So how will Home Capital fund new mortgages? That’s the core of its business. Via the $2 billion loan with the onerous terms? Hardly….
Here’s the killer: the value of the collateral.
On April 28, HOOPP CEO Jim Keohane told BNN in an interview that “for every $1 we lend Home Capital, they’re going to provide us with $2 of mortgages as collateral. That’s where we get our protection from.”
So the C$2 billion loan would be backed by C$4 billion in mortgages. In other words, in the eyes of Keohane, these mortgages might be actually worth, when push comes to shove, 50 cents on the dollar.
That’s what it took to make the deal. Keohane told BNN he feels “comfortable with the underlying quality of mortgages, particularly given the protection we have in terms of additional overcollateralization we have.” He said, “The scenario that would have to play out for us to lose money is pretty extreme.”
Keohane was on the board of Home Capital but resigned on Thursday as the deal emerged amid swirling conflicts of interest.
At the end of its rope, Home Capital is now evaluating “strategic options,” as it said. It hired RBC Capital Markets and BMO Capital Markets to look for a buyer or whatever other “options” it might still have. But it’s going to be tough. There will be a slew of lawsuits including class-action lawsuits, and potential buyers might not want to get tangled up in them.
The fact that the price of these “alternative” mortgages has been set at 50 cents on the dollar when push comes to shove – a reflection of the potential prices of the homes backing these mortgages – gives some clues about what insiders think the outcome might be of Canada’s magnificent no-holds-barred housing bubble.
Here I’m dismantling the old saw that “this can’t happen in Canada.” Read… Can US-style Housing Crisis, “Jingle Mail” Hit Canada’s Banks?