Bloomberg News

Home Capital CEO Sees Mortgages Book Doubling: Corporate Canada

May 23, 2013

Home Capital Group Inc. (HCG), the Canadian mortgage lender targeted by short sellers, plans to double its loan portfolio by adding customers turned away by the country’s biggest banks.

Canada’s largest non-bank mortgage lender aims to boost assets under administration to C$40 billion ($40 billion) in the next four years from C$20.4 billion in the first quarter of 2013, Chief Executive Officer Gerald Soloway said.

“There are a lot of situations where people would have been qualified with the banks and they have been shifted to us,” Soloway, 74, said in an interview yesterday at Bloomberg’s Toronto office. “With the mortgage tightening, it’s not economical for a thousand-branch bank to do what we do. We’re small and quite centralized so it works for us to put the skill and time into each loan.”

Home Capital can pick up “high quality” customers from banks, which are becoming more selective after Finance Minister Jim Flaherty tightened mortgage rules four times in the last five years, he said. The company is also expanding in St. John’s, Newfoundland, and Montreal, Soloway said.

The company will flourish by concentrating on the self-employed and new-immigrant markets and expanding its geographic footprint, Phil Hardie, analyst at Scotia Capital Markets, said in a May 9 note to clients.

Short Target

“We expect lenders focused on underserved markets are likely to continue to outpace industry growth,” Hardie wrote.

Home Capital dropped 10 percent this year as short interest rose to a record 28 percent of outstanding shares on May 15, data compiled by London-based Markit show.

Steve Eisman, the Emrys Partners LP founder who rose to fame betting against U.S. subprime mortgages, shorted Home Capital stock, he said at the Ira Sohn conference in New York on May 8. Short sellers profit from price declines by selling borrowed securities and replacing them with stock bought at cheaper levels.

“Home Capital is a stock that investors view as a good way to play the housing market in Canada,” Bryan Brown, analyst at Macquarie Capital Markets, said in a phone interview May 15 from Toronto. “If people were looking to short the housing sector, that is the stock they would go for. With the stock being shorted this much, it looks like investors are expecting a major correction in the Canadian housing market.”

Home Capital rose 0.7 percent to C$52.78 at 9:40 a.m. in Toronto. The stock has gained 35 percent in the five years through yesterday compared with a 6 percent rise in the 44-company Standard & Poor’s/TSX Financials index and a 14 percent drop in the broad S&P/TSX Composite index.

Significant Focus

Investors shorting Home Capital are betting on a collapse in the Canadian housing market after the average residential price climbed about 140 percent over the past 13 years, according to the Canadian Real Estate Association.

Economists such as David Madani at Capital Economics Ltd. forecast home prices may decline as much as 25 percent over the next two years, and the government forecasts housing investment will be a drag on economic growth over the same period.

The Office of the Superintendent of Financial Institutions is reviewing its guidance to banks on mortgages of more than 25 years. The effect of low interest rates on banks has become a “significant area of focus” for the regulator, said Julie Dickson, OSFI superintendent, at the Bloomberg Canada Economic Summit May 21.

Not Risky

Home Capital isn’t a risky investment as only 7 percent of its total mortgage portfolio is in the condominium market and the delinquency rate of the mortgage portfolio is 0.3 percent, Soloway said. Royal Bank of Canada, Canada’s largest lender, had total gross impaired loans of 0.36 percent in the fourth quarter of 2012. Toronto-Dominion Bank, the second largest, had 0.33 percent.

“We lend to what the market perceives as a riskier customer base but we do it in a very conservative way,” President Martin Reid said. “That’s where we think a lot of the people out of the U.S. who are shorting us don’t pay attention to, they’re just looking at the macro play.”

“I don’t think people who are shorting have done their homework,” Jason Donville, CEO of Donville Kent Asset Management, said from Toronto. “You’re not sitting with a balance sheet that has a bunch of junk on it.’”

Donville was chief investment officer of Home Capital in 2007.

Market Meltdown

“Will the Canadian real estate market melt down and if it does, who’s going to get hurt the most?” Donville said. “The probability of a big meltdown is low. And Home Capital is the best capitalized of the lenders so they won’t get hurt.”

Home Capital’s profit rose 14 percent to C$59.7 million in the first quarter of 2013 from the same period a year ago.

Eight analysts rate the shares a buy and three rate them a hold, according to Bloomberg data. The 12-month price target of nine analysts is C$68.70, or 29 percent more than the closing price yesterday.

Home Capital is also seeking approval from the bank regulator to sell the interest portion of its mortgages to improve capital capacity. The additional revenue may lead to a dividend increase, said Fred Westra, an analyst at Industrial Alliance, in a May 16 note to clients. Westra rates the stock a top pick.

Bank Regulation

Soloway said he “is hopeful” that the company will get the approval in the next few months.

Stephen Boland, analyst at GMP Securities, said in a May 9 note to clients that he’s not convinced OSFI will approve Home Capital’s request.

“Home Capital is a smart lender,” said Robert Gill, fund manager at Aston Hill Financial Inc. (AHF) which manages C$6.7 billion, including Home Capital. “They don’t care about a person’s history. They care about the real estate value. They know the value of every house on every street they lend to in detail.”

Gill is overweight Home Capital stock. “They’re taking over market share from competitors,” he said in Toronto. “And they can easily grow it further.”

To contact the reporter on this story: Katia Dmitrieva in Toronto at edmitrieva1@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net


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