Dear Mr. Morneau: It’s time to step in and save Home Capital
Jordan Hymowitz and David Taylor, Special to Financial Post
Friday, May 26, 2017
Finance Minister Bill Morneau appears at a Commons committee THE CANADIAN PRESS/Sean Kilpatrick
Funds that we manage own shares in Home Capital Group Inc., the majority of which were purchased after the major sell-off last month. We are writing to ask Finance Minister Bill Morneau to act to save the company, which we believe is the victim of aggressive U.S. investment bears who are drawing unwarranted comparisons with the 2008 U.S. housing crisis.
A series of increasingly lax underwriting standards (i.e. 2 per cent money down and 40-year terms) fueled a speculative boom in which lenders spread the risk through the securitization market. No reputable agency Moody’s, Standard and Poor’s, Goldman Sachs, etc… raised the spectre of a housing bubble because they were making too much money in underwriting/rating/syndicating loans. Rather they ignored/explained away the weakening monthly credit quality data and said falling housing prices were impossible.
Canada was one of the few industrialized nations in 2008-2010 that did not have a mortgage bubble that lead to an asset quality issue which subsequently promulgated a banking crisis/recapitalization. Why? Put simply, Canada,s underwriting standards, among the strictest in the world, never weakened. Down payment minimums were never watered down in an attempt to achieve low-income housing affordability targets or community investment act targets. Nearly all provinces in Canada (except Saskatchewan and uninsured mortgages in Alberta) have recourse mortgages (particularly the provinces where alternative mortgages are more prevalent). That means an owner can’t just walk away from his house scot free, lenders go after your wages, your car, and any other assets, including hockey skates! There is no tax deductibility of mortgages in Canada.
Let’s look at the facts. Canada Mortgage and Housing Corporation (CMHC’s) delinquent loans in 2016 were only 32 basis points of the total loan book. Fannie Mae, the U.S. counterpart, had serious delinquent loans of 112 basis points or 3.5x-times greater â€” in 2016. Home Capital’s alternative mortgages, a category the bears often falsely associate with subprime had only 24 basis points of delinquent mortgages in the first quarter of 2017 and one basis point of annualized net charges. This means Canada’s alternative mortgages are today performing nearly 75 per cent better than fully underwritten conventional mortgages in the United States. Said another way, Home Capital lost less than one dollar for every $1,000 lent in the latest reporting period.
Yet facts don’t deter Canadian housing market bears. In search of the Big Short, Canadian edition, U.S. hedge funds have been aggressively shorting Canadian banks and mortgage companies. Each day a new hedge fund shorts Canada and brags to its shareholders how smart they are in newsletters and on television. Bloomberg and other news outlets are filled with news stories with titles like, Contagion fears rise in aftermath of Home Capital Group’s collapse. Each story seems to surpass the last in hyperbole and sensationalism.
Shareholders, borrowers and depositors don’t deserve to be taken down by a combination of a disclosure dispute with a provincial regulator and U.S. short-sellers
In an absolute sense, the bears have been right on the Home Capital short. The stock has declined about 65 per cent in the past 3 months. But they were right for the wrong reasons. Home Capital, we believe, was a victim. It was third-party brokers who are alleged to have fraudulently altered mortgage applications. That operational issue became a disclosure issue when the provincial securities commission alleged that the mortgage concerns were not disclosed in a timely manner.
To be clear, we believe there is no excuse for the failure to report the fraudulent broker activity in a timely manner. We support the recommendations to punish management by the OSC. However, the key bear narrative, that current management is covering up massive asset quality issues at Home Capital, does not fit the data set. In fact, Genworth Canada, which has insured a large amount of the mortgages that were fraudulently submitted by third-party brokers to Home Capital, announced on April 26 that, at present, our delinquency rate with respect to Home Capital originated mortgages is less than our overall business delinquency rate of 0.21 per cent.
There is still no evidence that asset quality issues exist today in Home Capital’s mortgage portfolio, or anywhere in Canada. However, the crisis of confidence and run on deposits has resulted in alternative mortgage rates rising by at least 50 basis points and perhaps as high as 100 basis points in some instances in the month of May, an increase of between 10 per cent and 20 per cent. The increase in mortgage rates has levied a tax of at least $300 per month in the form of higher monthly payments for every Canadian securing an alternative mortgage in May vs. April. While the Canadian government may want to slow down the rate of price increases for the “fat cat” foreigners and executives buying million-dollar downtown condos, do they really want to put the brakes on home ownership for striving immigrants or cash income workers in the outer ridings? Does Canada really want to let fear of an asset quality issue develop into an actual asset quality issue which drives the cost of capital higher for all other financial institutions and sends reverberations throughout the Canadian financial markets?
Finance Minister Bill Morneau should, as his predecessor did in 2008-2010, provide stronger leadership to calm the waters in the Canadian finance sector. He should encourage Canada’s big banks to do what they recently did for another alternative Canadian mortgage company (Equitable Bank), provide a lending backstop that halts a run on deposits and gives Home time to move forward. Perhaps a short-term lending facility by the Bank of Canada accompanied by a Ministerial statement to Home depositors and mortgage holders about the guarantees provided by the CDIC would help.
Home has an impressive track record in the Canadian housing market serving a niche of hard-working first-generation Canadians. Shareholders, borrowers and depositors don’t deserve to be taken down by a combination of a disclosure dispute with a provincial regulator and U.S. short-sellers. Asset quality is not an issue in Canada, nor is the strength of the larger banking sector, but a failure by the Canadian government to act on the Home Capital funding issue could lead to The Big Short 2, Canadian edition.
Jordan Hymowitz is Managing Partner of Philadelphia Financial Management, a U..S. hedge fund with more than $500-million in assets. David Taylor is President, Chief Investment Officer and Portfolio Manager at Taylor Asset Management, a Toronto firm with $1-billion in assets.