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Here's the question every deep-value, consensus-loathing, risk-loving investor is asking themselves right now: Is Home Capital Group Inc. a buying opportunity?
While vocal short-sellers continue to cheer the falling stock and many long-term investors bail out of their positions following last week's precipitous decline, the stock is now attracting a new group of investors.
David Taylor, chief investment officer and portfolio manager at Taylor Asset Management, is one of them: His firm, which has about $1-billion in assets, has taken a 4-per-cent stake in Home Capital Group, after buying the shares when they traded between $5 and $7.
Read more: The rise and fall of Home Capital
His optimism rests on the book value of the company, which he estimates is between $15 and $28 a share.
The shares fell 13.4 per cent on Monday, closing at $6.96 in Toronto. They traded below $5.99 and $8.40 during the past four trading days, down from $26 as recently as April 1, amid deep concerns about the company's financial health as depositors pulled their money out of high-interest savings accounts.
"I think people are being overly negative on the nature of the business and the fundamentals of the business," Mr. Taylor said. "If you're willing to stomach the risk, I think you are being more than compensated for the rewards."
The upside? He figures you can triple your investment.
Yes, Home Capital Group is paying a hefty rate for its line of credit, after agreeing to a $2-billion financial lifeline from a pension fund. The rate will decimate company's profit.
But Mr. Taylor is confident that the underlying mortgages are healthy. As these mortgages run off, they'll likely to sold to other financial firms, generating cash that will match the guaranteed investment certificates that depositors are redeeming.
"The asset quality is very strong here," Mr. Taylor said. "The only thing that has been damaged here is the confidence in the company."
He's not alone. Bloomberg reported that San Francisco-based Philadelphia Financial Management bought more than one million Home Capital Group shares over the past week, as a bet that the company will be acquired.
"The entire problem here is not an asset-quality issue, it's purely a liability problem," managing partner Jordan Hymowitz told Bloomberg. "The liability problem solves itself overnight by being acquired by a more stable financial institution."
The problem with this argument is that the ideal buyer is hard to see. The big banks are probably out, because they don't underwrite the non-prime mortgages that are Home Capital Group's specialty.
Other players in the mortgage market also are not willing to step up. Canadian Western Bank has said it is not interested in the company and Laurentian Bank of Canada has sounded similarly uninterested.
But Mr. Taylor's enthusiasm works even if Home Capital Group's assets are carved up. What the company needs, though, is a new board and a strong chief executive officer with a healthy relationship with the big banks.
"The risk is that as these mortgages become due, there is no one else to finance them, and these GICs become due," Mr. Taylor said. "Then there is a mismatch."
But he said that, given the strong quality of these mortgages, he can't see a scenario in which they do not get refinanced.
"If they can collapse these mortgages, run the book off, pay off the GICs, then the book value is $25," Mr. Taylor said.
The bullish view on the stock follows an extraordinary month for the company.
Earlier this month, the Ontario Securities Commission alleged that three current and former senior executives did not properly disclose underwriting irregularities to investors. Depositors withdrew money from their high-interest savings accounts and banks imposed caps on client purchases of Home Capital Group's guaranteed investment certificates (GICs).
Home Capital Group announced last week that it was arranging a $2-billion financial lifeline to offset depositors who were withdrawing money, in what a number of observers have called a classic run on the bank. The share price fell 65 per cent in a single day.
The lifeline, led by Healthcare of Ontario Pension Plan (HOOPP), came with onerous terms that will see Home Capital Group paying an effective rate of 22.5 per cent on the first $1-billion draw – killing the company's profits and raising questions about its future.
Many long-term investors who had stood by the company when it was generating good news and strong profit growth, bailed out of the falling stock "We had to confront an investment gone wrong in Home Capital Group this week," Ian Cooke, a portfolio manager at QV Investors Inc., said in a letter to clients on Friday.
QV had been one of Home Capital Group's largest shareholders, with a 12.8-per-cent stake in the company "Although a case can be made for deep value in the stock, the business has failed to demonstrate the qualities and execution we expect. We have exited the investment," Mr. Cooke said.
Baskin Wealth Management, which said that Home Capital Group shares represented about 0.7 per cent of its clients' holdings, also sold its entire stake last week (at a price of $18.11 per share, it said) after holding the stock for 14 years.
"We do not normally sell into a falling market, nor do we succumb to emotion-driven selling or panic," David Baskin, president of the investment firm, said in a note to clients.
"Our primary reasons for this decision are our new lack of confidence in the integrity and effectiveness of company management, and the possibility of a lack of confidence in the company's viability on the part of key financial industry players," Mr. Baskin said.
According to Bloomberg, Mawer Investment Management sold 2.8 million Home Capital Group shares last week.
"The assets look, at this point, still reasonably good," Jim Hall, Mawer's chief investment officer, told Bloomberg. "Confidence was lost in this company and the business model breaks apart. That's the problem with banks."
Many short-sellers are now gloating on Twitter. John Hempton of Australia's Bronte Capital, took a more analytical approach to the company on his blog (and disclosed that, as a short-seller, he has a "vested interest in its collapse").
He focused on the extraordinary lifeline in arguing why the stock is a sell.
"This is desperation financing," Mr. Hempton wrote on Saturday. "They are securing mortgages (average interest rate below 5 per cent) to borrow funds that cost 15 per cent or more. The negative carry is huge. A financial institution cannot stay in business under these terms."
Even bullish investors acknowledge that the road to a payoff might not be smooth, especially if the mortgages coming due aren't refinanced.
"I can't see that scenario," Mr. Taylor said. ""I just can't see the banking community allowing something like that to happen."
David Berman