Why Did Home Capital Group Inc. Drop 15%?

Home Capital Group Inc. (TSX:HCG) is a former market darling. Is the 15% decline the beginning of even more bad news?

| More on:
The Motley Fool

As I type this, shares of Home Capital Group Inc. (TSX:HCG) are getting hammered, down more than 15% compared with the closing price on Friday.

Let’s take a closer look at what happened and whether or not the depressed price is now a buying opportunity.

The skinny

After the market closed on Friday, Home Capital gave investors a preview of upcoming second-quarter results, which are scheduled to come out at the end of the month. To put it mildly, they weren’t pretty.

Traditional loan originations in the second quarter fell to $1.29 billion, a decline of more than 15% compared with the same quarter last year, when it issued more than $1.5 billion in new loans. Insured mortgage originations took an even harder hit, falling from $620 million to $280 million year over year.

For a company that’s consistently impressed the market by beating growth expectations, these numbers were absolutely terrible. It’s little surprise that shares have declined so aggressively on these results.

Analysts aren’t giving the company any love either. In research notes issued Monday morning, analysts from TD, Royal Bank, Cormark Securities, and Macquarie all downgraded shares, although TD analyst Graham Ryding still has a $46 price target on the stock.

What’s more interesting than Home Capital’s results is the far-reaching implications for the Toronto real estate market.

The bigger picture

The Toronto real estate market has been the overwhelming factor in driving Home Capital’s stratospheric growth over the past decade. The company has attempted to expand outside of its home market, but without much success. Currently, about 90% of the loan portfolio is concentrated in the Greater Toronto Area.

Weakness in Home Capital’s business points to either one of two things. Either the company is running out of borrowers, or the real estate market is starting to soften. Neither of those are things an investor wants to see.

This could be the beginning of a pretty nasty cycle. Home Capital bulls have always said the company had such tiny loan loss reserves because it was a skilled underwriter. Bears have countered by saying that increased real estate prices and a healthy economy just bailed out borrowers that got into trouble.

With Canada’s economy starting to falter and loan originations down, it’s easy to now envision a scenario where the bears could end up being right. Additionally, many feel Home Capital’s loan loss provisions of just 0.07% are woefully inadequate, especially when you compare them with many of Canada’s other major lenders.

There’s also the argument to be made that Home Capital is a leading indicator for the Toronto real estate market. The first step of any downturn is a slowing of new mortgages followed by the more nasty stuff. With many pundits now calling Toronto’s market a bubble, many investors are getting out now and asking questions later.

Personally, I think a major downturn in the Toronto market could be almost fatal for Home Capital. But even if the company manages to contain the damage to its balance sheet, it still has to deal with sentiment. It’ll become a proxy on Toronto real estate, which isn’t a good place to be when the market is declining. Investors will start to short it, and it’ll be subject to huge price swings.

That’s not the type of company I want in my portfolio. Combining that with my belief that the real estate market in Toronto is past due for a correction, I’m still staying far away from this company. Even after the 15% fall, I think there could still be more downside.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith has no position in any stocks mentioned.

More on Bank Stocks

open vault at bank
Dividend Stocks

1 Magnificent TSX Dividend Stock, Down 10%, to Buy and Hold for a Lifetime

A recent dip makes this Big Bank stock an attractive buying opportunity.

Read more »

dividends can compound over time
Dividend Stocks

Why TD Stock Below $80 is My Top Pick for 2025

The Toronto-Dominion Bank (TSX:TD) is both cheap and growing heading into 2025.

Read more »

Man data analyze
Bank Stocks

Where Will TD Stock Be in 3 Years?

TD offers opportunities for income and total return investors alike who are willing to hold for the long haul.

Read more »

analyze data
Bank Stocks

Best Stock to Buy Right Now: National Bank vs. Bank of Montreal?

Two big bank stocks poised to make big moves in 2025 are the best buys right now.

Read more »

calculate and analyze stock
Bank Stocks

Royal Bank of Canada: Buy, Sell, or Hold in 2025?

The TSX’s largest company by market capitalization is a buy-and hold stock for long-term investors.

Read more »

Man data analyze
Bank Stocks

TD Bank: Buy, Sell, or Hold in 2025?

TD Bank (TSX:TD) is historically seen as a great stock. But given its recent troubles, is it a buy, sell,…

Read more »

customer uses bank ATM
Stocks for Beginners

A Dividend Giant I’d Buy Over TD Stock Right Now

While TD Bank recovers from a turbulent year, this dividend payer with a decent yield and lower payout ratio is…

Read more »

Piggy bank in autumn leaves
Bank Stocks

TFSA: Here’s How to Bump Up Your Contribution for 2025

The TFSA is a great way to create income, and investing in this top bank stock can certainly create even…

Read more »