Is a potential Ontario Securities Commission enforcement action for things that took place nearly two years ago old news? If a stock falls on the announcement, does it become even more of a buy?
Perhaps the answers for the company's boosters are "yes," in the case of Home Capital Group Inc. The company revealed Friday the OSC sent it an enforcement notice related to its continuous disclosure obligations in 2014 and 2015 about false loan applications and the brokers involved in them.
Home Capital shares, struggling to recover from an underwhelming earnings announcement last week, dropped another $1.77 Monday to close at $27.94, roughly 30-per-cent off its 52-week high.
It is quite the comedown for what has been a long-term top performer in the S&P/TSX Composite and makes many lists of top dividend stocks for raising its payout year after year.
The answers for me, however, are "no" – and investors who are keen on avoiding the risk of companies who have a problem with getting their disclosure right might want to steer clear of Home Capital's shares.
The OSC's notice reflects its "preliminary conclusion" that Home Capital failed to meet continuous disclosure obligations. The notice, says analyst Jaeme Gloyn of National Bank Financial, is not yet a formal proceeding; instead, it allows Home Capital to discuss the allegations, present new evidence and perhaps even enter into settlement talks. (Home Capital spokeswoman Laura Lepore said Monday that "we will not be commenting beyond the [news] release.")
What is the issue, since you may have forgotten? Well, we already had an inkling the OSC may have been unhappy with the company. On July 10, 2015, Home Capital issued a market update on its single-family mortgage origination volumes for the second quarter, which had ended 10 days prior. It filed a Material Change Report with regulators on July 17, a week later. The news was that Home Capital suffered a sharp drop in originations, in part because its "ongoing review of its business partners led to the Company terminating relationships with certain mortgage brokers, which caused an immediate drop in originations."
However, on July 29, Home Capital had to issue another news release and an amended Material Change Report, at the request of the OSC, which "provide[d] additional disclosure" on the terminated relationships. The new report revealed the company learned "in late 2014" from "an external source" of "possible discrepancies in income verification information submitted by certain mortgage brokers."
The company says it "immediately" began an investigation, identified brokers associated with the false information and "suspended its relationship" with 45 individual mortgage brokers "during the period of September, 2014, to March, 2015."
Now, let me underscore the timeline for you: The termination of brokers, which "caused an immediate drop in originations," concluded in March, in the first quarter. The company did not disclose the issue when it reported its first-quarter earnings on May 6. It did not disclose the issue at any time in the second quarter, as it was experiencing the sharp drop in originations. It disclosed the impact July 10, after the second quarter ended – but did not reveal when, exactly, it knew it had this problem.
The OSC's directive to disclose more information showed the company had plenty of time after it knew it had the problem – and felt the impacts of the problem – and didn't tell investors what was coming.
In fact, in releasing the results for the first quarter of 2015, then-CEO Gerald Soloway cited "cold weather" as a factor in slowing originations, even as he had said in early 2014 that Home Capital was able to increase originations "in bad weather and everything."
Is this ancient history? Well, Mr. Soloway, the company's founder, has retired, but he's still on the board of directors.
Robert Blowes, the chief financial officer when the investigation started in 2014, retired before the end of that year, but also remains on the board. Martin Reid, president at the time, has now succeeded Mr. Soloway as CEO. And while there are some new names in senior finance roles at the company, the members of top management that should have been discussing how to disclose this matter in 2014 and early 2015 all remain with the company in one role or another. Certainly, the current problems with Home Capital's stock price are largely financial. Last week, the company replaced its "mid-term targets" with "long-term objectives," which Mr. Gloyn of National Bank said "validates our view that HCG will fail to meet its objectives in the near-to-medium term."
Analysts are sour, with just two of 11 recording buy ratings, according to Bloomberg, and four offering up sell recommendations. Dylan Steuart of Industrial Alliance Securities Inc., one of the "holds," calls the OSC enforcement notice "another overhang on sentiment." Indeed. Home Capital, in its disclosure Friday afternoon, says it "believes that its disclosure satisfied applicable disclosure requirements." The overhang, I think, should remain until the company backs off its defence of what it did in 2015, and some of the folks responsible for it find new opportunities somewhere other than Home Capital.
David Milstead