Three housing-related stocks are among the 10 companies with the largest percentage of outstanding shares sold short.Chris Helgren/Reuters
A large or rising short position can be a red flag warning of trouble ahead for a company. Let's look at some of the red flags currently hoisted on the Toronto Stock Exchange, particularly housing-related companies.
The accompanying table shows the 10 companies with the largest percentage of outstanding shares sold short (compiled by Markit Ltd. in late September, using the number of shares loaned out on North American exchanges).
Note the three housing-related stocks: Home Capital Group Inc., Canadian Western Bank and Boardwalk Real Estate Investment Trust.
Home Capital Group, the largest non-prime mortgage lender in Canada, topped the table with 32.4 per cent of its outstanding shares sold short.
Six months ago, it was in seventh place, at 25 per cent. The company's stock price has tumbled nearly 25 per cent since then.
For Mark Cohodes, an American poultry farmer and retired hedge-fund manager, Home Capital Group is a way to bet on the Canadian housing market. Like a number of other short sellers, he sees a bubble about to burst because prices have outrun incomes so much, especially in the Toronto area where Home Capital Group is concentrated.
But are Canadian houses really that unaffordable? According to the Bank of Canada's Housing Affordability Index, affordability at the national level remains at its long-term average thanks to declining mortgage rates.
Is the red flag more a warning to short sellers about the possibility of a short squeeze?
Yet other short sellers are focused on the quality of Home Capital Group's mortgage portfolio and its lower loan-loss provisions compared with the major banks.
Management, for its part, is working on keeping questionable mortgages off the books while supporting the stock through buybacks and a rising dividend (now yielding 3.5 per cent).
Canadian Western Bank is fifth on the top 10 list, with short selling at 24.8 per cent of outstanding shares.
Its mortgage portfolio is concentrated in Alberta, so short sellers are betting that low oil prices will lead to an increase in mortgage arrears and defaults.
Six months ago, the short position in the bank's shares was the largest of all TSX stocks at 37 per cent.
Short sales have thus eased considerably with the partial recovery in oil prices since the spring. The share price is up marginally, too.
However, Lighthouse Partners portfolio manager Jerome Hass warns that loan impairments take time to show up. In the case of the 2008 recession, they didn't peak at the bank until two years after the onset of the downturn.
Boardwalk REIT's short interest is equal to 22.6 per cent of outstanding shares.
It has a concentration of rental properties in Alberta: Short sellers are betting on vacancies rising as workers in the energy industry lose jobs and leave the province.
Larry MacDonald is an economist, author and financial writer. His website is at larrymacdonald.serveblog.net.