Home Capital looks for second act after its remarkable bounce back from the brink
The Financial Post takes a look at 11 people and companies we’ll be watching closely in the new year.
In a wood-panelled room at Toronto’s Fairmont Royal York Hotel late in November, alternative mortgage lender Home Capital Group Inc. delivered its latest pitch to analysts and investors.
That there were investors to pitch might have shocked those who gave up on the company more than two years ago. In the spring of 2017, the Toronto-based lender’s stock price cratered and depositors pulled out their money after it was accused of making misleading statements about a decline in mortgage originations.
We set out not only to fix Home, but also to build and grow Home
CEO Yousry Bissada
As chief executive Yousry Bissada told his audience, “we set out not only to fix Home, but also to build and grow Home.”
As part of that transformation, he said the lender wanted to create a culture that was “transparent, accountable and had sustainable risk as part of its core management style.” It also sold off “non-core” parts of its business and bought a lot of its stock back.
The strategy seems to have worked. Home Capital said it has retaken the top spot in the mortgage market for loans to people who do not qualify as either prime or sub-prime — a category the industry calls Alt-A — its credit rating has been upgraded and, perhaps more important to some investors, it has become a Canadian stock market darling, with its shares more than doubling in value during 2019.
That was 2019, though, and you can’t fault investors for wondering what Home Capital can do to keep the momentum going. A successful corporate comeback is often a tough act to follow.
Home Capital’s bread-and-butter business remains mortgages and Canada’s alternative mortgage market, where the company primarily competes, is worth roughly $371 billion, or almost 25 per cent of the country’s total mortgage market, according to Ed Karthaus, Home Capital’s executive vice-president of sales and marketing.
The company is now eyeing opportunities to grow in major urban centres, namely Vancouver, Calgary, Montreal and Toronto. It is also looking to diversify its balance sheet somewhat, as the lender set a target of getting commercial mortgages up to 15 per cent of its total on-balance sheet loans over the next three years or so, from its current level of around 10 per cent. The lender’s total loan portfolio at the end of the third quarter was $17 billion.
Canada’s economic environment has been supportive of growth in the mortgage market. In particular, the housing market appears to be on the upswing again after the new mortgage stress tests and foreign buyer taxes that were implemented in previous years put the brakes on.
“With stable unemployment, no signs of interest rate hikes that could derail current mortgage debt servicing levels, solid credit performance and several quarters of clear proof that HCG’s niche market of new Canadians, self-employed individuals and those with bruised credit supports a growth rate well above that of the broader mortgage market, the macro is certainly brighter,” Raymond James analyst Brenna Phelan said in a recent note.
A hint of where Home Capital plans on going next can be found in three words ‘sustainable risk culture’
There’s no doubt Bissada is proud of what Home Capital has managed to achieve since he was appointed in August 2017. After all, the name of November’s investor day was “Proud of our Home.” Bissada also highlighted subsidiary Home Trust Co., which in 2019 won the Lender of the Year: Bank award at the Mortgage Awards of Excellence.
“That’s quite a big honour in particular when you look at how far we’ve had to come along in those two years,” he said. “We’ve had much more achievement structurally and operationally.”
Reviews of the investor day were positive as well.
“The presentations not only introduced HCG’s relatively new management team (most executives joining in the last two years), but also highlighted the significant steps taken (and soon to be taken) to modernize the operations since the liquidity crisis in 2017,” National Bank Financial analyst Jaeme Gloyn said in a Nov. 26 note.
Some of those steps include the lender’s willingness to pour millions of dollars into buying back its own stock. The company has also been toying with the idea of reinstituting quarterly dividend payments, which it suspended during the liquidity crunch.
Gloyn also noted that shares were trading at approximately 1.3 times their tangible book value at the time, which largely reflected the company’s outlook.
Furthermore, Home Capital has benefited from a recent resurgence in the Canadian housing market and an economic cycle that has yet to quit its upturn and fall into recession. A change in the forecast could give the lender and its peers a jolt.
But Home Capital’s competitors are unlikely to take next year off either. Loan growth at Canada’s big banks has been slower than in previous years, so they may become a bit more aggressive with their pricing. Some lenders are already starting to creep into the high end of Home Capital’s Alt-A market, Bissada noted, which could perhaps lead investors to worry the company will move into riskier loans.
But a hint of where Home Capital and its approximately 750-person workforce plan on going next can be found in three words, “sustainable risk culture,” which was a phrase thrown around often at the investor day.
“It’s a source of our strength,” Bissada declared.
In an interview afterward, he said the company acknowledges it takes a risk every time it lends money, and, therefore, must price that risk accordingly and ensure any risk taken falls within its set limits. The message to employees, then, is not to take undue risk.
“It’s in everything we do,” Bissada said. “Whether it’s technology … underwriting, servicing, that the risk is considered and that we do it intelligently. In the absence of that, you’re going to get motivated by other poor things.”
M Partners analyst Andrew Hood said the focus on a sustainable risk culture is key to smoothing over concerns people may have about the Canadian real estate market, as well as Home Capital’s recent history. The company, he noted, stressed it will zoom all the way down to the neighbourhood level when it is deciding to whether to make a loan.
“They might not touch this whole little section within Vancouver that might have these really overpriced luxury homes, whereas there might be a region 10 minutes down the street that they’re willing to sell homes into,” Hood said. “They’re really hyper-focused, looking more specifically at the income levels and sustainability of prices in individual areas, and having these teams specialized within those areas.”
The biggest bet that Home Capital seems to be making is on itself. For the year ended Sept. 30, the company bought back more than $390 million in stock.
More buybacks are coming. Home Capital in early December announced it was officially beginning a “substantial issuer bid,” under which it is offering to repurchase and cancel up to $150 million of its shares. The offer expires at the end of the workday on Jan. 10, and the company plans on renewing a more normal-sized round of repurchases at some point afterward.
In addition to the buybacks, Home Capital is spending on technology, which Bissada called “table stakes” for any executive. The plans include spending around $60 million over three to five years on upgrading its information-technology systems.
At the investor day, Home Capital’s chief digital and strategy officer Benjy Katchen said the company had also relaunched its mortgage broker portal called Loft in the third quarter of 2019, shifting it to a mobile-first model.
The lender is now using the same design for a future portal for deposit brokers, he said, and planning to launch a new loan origination system in 2020 as well.
In tandem with building up certain parts of its business, Home Capital has been willing to get out of other parts it no longer deems crucial by selling them off.
For example, it announced on Dec. 11 that it had determined its point-of-sale lending business fell into the latter category following a review of its consumer retail loan portfolio.
As a result, the company said “non-core” loan balances of around $84 million would be treated as assets held for sale for accounting purposes.
Home Capital has also telegraphed it will issue more residential mortgage-backed securities in 2020, something it did for the first time in 2019, which helped broaden its sources of funding.
During the third quarter, Home Capital closed a $425-million private placement of residential mortgage-backed securities that were backed by a portfolio of “classic” single-family home loans that were not insured against borrower default.
“The company expects to be a serial issuer of these securities, subject to market conditions,” Home Capital said in its outlook.
This diversification adds to the changes already happening with Home Capital’s $13.5 billion or so in deposits. Nearly a quarter of the deposits have come from its direct-to-consumer channel Oaken Financial (which was only launched in 2013), and 95 per cent are fixed term, meaning they can’t be withdrawn at a moment’s notice.
“They’ve got tons of liquidity,” Hood at M Partners said.
There are, however, lingering concerns about the Canadian housing market and the relatively large amount of debt the average consumer holds.
The federal banking regulator, the Office of the Superintendent of Financial Institutions, recently hiked the amount of capital that Canada’s biggest banks (which do not include Home Capital) must hold, saying the decision reflected its view that key risks remain high.
“The key vulnerabilities include Canadian household indebtedness, asset imbalances and institutional indebtedness,” OSFI said. “In addition, global vulnerabilities related to ongoing trade tensions and rising leverage are growing, which could increase the chance of a spillover of external risks into the Canadian financial system.”
Bissada, though, said the housing market’s momentum has been positive and steady.
“Our view is it’s going to continue to be steady for next year,” he said. “We don’t think there’s any craziness that’s going to happen either way, up or down.”
Demand among Home Capital’s key customer demographics — new Canadians, the self-employed and those with poorer credit — is growing, while supply remains constrained, particularly in Toronto and Vancouver.
Bissada said the company’s foundation is strong, but there could be investors who need more persuading, setting up 2020 as a key year.
“We’re not sitting here saying we’ve reached our destiny,” Bissada said. “We’re on a journey.”