Crisis-stricken non-bank mortgage lender Home Capital Group Inc. (TSX:HCG) continues to struggle, despite surviving a massive bank run that almost caused it to collapse. While there are fears that the embattled lender may still collapse, management is doing everything it can to right the ship. This has sparked greater confidence among investors, causing its shares to pop by 36% over the last month.
Now what?
The most crucial aspect of the crisis that has engulfed Home Capital that investors need to understand is that the crisis is not related to the quality of its loan portfolio but rather to a loss of confidence that triggered a run on its deposits. That was sparked by a confluence of events relating to an investigation by the Ontario Securities Commission centered on allegations relating to the company misleading investors and failing to meet its disclosure requirements.
At this time, there is no hint of its mortgage portfolio being composed of ultra-high risk or fraudulent loans, despite the claims of some pundits and the fraudulent mortgage scandal uncovered in 2015.
This becomes apparent when taking a closer look at Home Capital’s first-quarter 2017 results. Non-performing loans as a percentage of the value of total loans under management was a mere 0.24%, or 10 basis points lower than a year earlier.
Nonetheless, Home Capital has prudently increased its allowances for credit losses by 17% year over year to now having a coverage ratio of 92%, well up from the 63% reported for the same period in 2016.
The biggest issue facing the lender is its ability to maintain sufficient liquidity to remain as an ongoing concern. On-call deposits have plummeted catastrophically to $250 million compared to almost $2.4 billion at the end of the first quarter.
Deposits payable on a fixed date made up of guaranteed investment certificates (GICs) have fared far better. They now total $12 billion, which is roughly $2 billion lower than they were at the end of March. More importantly, as of June 5, 2017, only $142 million of its GICs are payable, meaning that a run on that portion of Home Capital’s deposits is unlikely.
These numbers underscore the peril that Home Capital faces.
You see, Home Capital only has just over $1 billion of available liquidity, including $350 million remaining on the $2 billion credit lifeline provided by a syndicate led by the Healthcare of Ontario Pension Plan. This also means that it has drawn down over $1.6 billion from that extremely expensive credit facility, which is estimated to have an effective interest rate of over 22%. The extortionately high interest rate has increased Home Capital’s expenses, further squeezing its margins.
Such limited liquidity makes it extremely difficult for Home Capital to fund new mortgages. If it can’t write new, profitable business there is every likelihood that the embattled lender can’t continue as a going concern.
It also makes it difficult for the lender to roll over existing mortgages. Home Capital has estimated that the value of its single-family residential mortgage portfolio could fall in value by as much as 21% between now and the end of 2017. That too will have a sharp impact on its bottom line.
So what?
Home Capital is currently working furiously to lock in longer-term funding solutions for its liquidity issues. There is no guarantee that it can survive the current crisis in its present form, even if it successfully resolves the liquidity problem. The reputational damage to Home Capital is tremendous. Coupled with constrained liquidity and a sharp decline in profitability it will weigh heavily on its ability to maintain its much-needed broker network and write new business.
There is a long way to go before Home Capital is out of the woods, and that is before even considering the securities commission investigation and existing lawsuits.
