Mortgage company Home Capital Group Inc. has officially branded its post-crisis era “Home 2.0,” but some employees just call it “the comeback.”
Fifteen months after Yousry Bissada took over as chief executive officer, it’s still a work in progress. The most visible scars from a crisis that pushed Home Capital to the brink of insolvency last year are beginning to fade. The bunker mentality that weighed on many employees – the ones who didn’t leave – has eased, and the alternative lender is turning a profit while gradually refilling its mortgage-business pipeline.
The company now faces a new array of challenges, including stiffer competition for clients and prospective homeowners who are already feeling increasing financial pressure from rising interest rates. Just as Home Capital looked to be recovering, some of the air pressure went out of major urban housing markets, and there are now more lenders battling for slices of a smaller pie.
That’s partly a response to the vulnerability of Home Capital, which had been Canada’s clear leader in “near-prime” mortgage lending until last year’s troubles, and is now determined to reclaim the top spot. Near-prime customers are those who cannot get mortgages from the major chartered banks for a variety of reasons, such as having a volatile income or a lower credit score.
The question on investors’ minds is no longer one of survival, but rather: How profitable can the new Home Capital be?
Home Capital’s newfound stability has come at a significant cost. It now relies far less on cheap demand deposits brokered by investment dealers to fund its mortgage loans. The Bank of Canada has highlighted the risk in depending on such short-term funding, citing last year’s run on Home Capital’s high-interest savings deposits as evidence, and Home Capital has learned its lesson.
Most of its funding now comes from more stable fixed-term products such as guaranteed investment certificates, but those are more costly to offer. To attract money, it is offering interest rates as high as 3.6 per cent on five-year GICs from its Oaken Financial subsidiary.
Profitability has collapsed: At its peak in fiscal 2014, Home Capital earned nearly $4.50 a share, according to Standard and Poor’s Capital IQ. In the 12 months ended June 30, it earned $1.55.
The lender is also sitting on excess capital, and some shareholders are growing impatient as they await a plan to return some of that cash through dividends or share buybacks. At $12.80, Home Capital’s shares are languishing well below precrisis levels, trading at a steep discount to the lender’s book value, which was $23.40 a share as of June 30.
“They’re still on a path to normalization,” says Jaeme Gloyn, an analyst at National Bank Financial Inc. “That journey hasn’t yet been completed.”
Mr. Bissada insists that Home Capital’s core business model is still sound. The lender made its name by catering to borrowers who don’t quite fit the profile to qualify for a mortgage at a prime lender, such as a major bank. Many of its clients are new immigrants with short credit histories in Canada, or self-employed workers who find it harder to prove their incomes – both growing demographics. These borrowers also pay higher interest rates on home loans from Home Capital – typically 4.5 per cent or more – to compensate for their riskier profiles.
Home Capital hired outside consultants to do a deep analysis of the market, bolstering Mr. Bissada’s conviction that Home Capital is an “extraordinarily healthy business to keep investing in,” he says, tucking into a sandwich lunch in his office, flanked by chief financial officer Brad Kotush.
When Mr. Bissada joined Home Capital as CEO last August amid an overhaul of its senior management and board, the company was badly damaged. Nearly a third of its 910 staff had resigned after allegations that the company misled investors about fraud in its mortgage broker channel scared off investors, sparking a run on deposits. In the depths of the crisis, Home Capital was forced to tell brokers, “we can’t fund your mortgage. … Go find another lender,” Mr. Bissada says.
Even as Home Capital’s funding stabilized – with help from an equity infusion by Warren Buffett’s Berkshire Hathaway Inc. − Home Capital’s employees were still shell-shocked. “Everybody had PTSD,” Mr. Bissada says. “They were afraid to do anything” and quick to pass on deals, slowing the firm’s recovery.
“The brokers were willing, but we weren't staffed,” he says. “And we were under a more rigorous risk culture.”
After recent hiring, Home Capital is back up to 750 staff and issuing new mortgages at a faster pace – $1.23-billion of loans in the second quarter, including some commercial mortgages as it rebuilds a portfolio sold off in desperation last year. But its underwriters are working under more rigid rules, and must be less willing to overlook shortcomings in loan applications simply because the borrower has a hefty down payment. “Every mortgage is looked at in a deeper way to make sure it fits us,” Mr. Bissada says.
The vast majority of Home Capital’s loans are concentrated in Southern Ontario, and Mr. Bissada has plans to invest to improve the company’s presence in cities across the country.
In time, he says he hopes Home Capital will use technology to be better and faster at making loan decisions, and says he sees promise in the “California gold rush” to harness artificial intelligence. Home Capital’s board hired Mr. Bissada in part for his experience running digitally oriented firms such as Filogix, a software provider to the mortgage industry that had Home Capital as a client. A key part of his job is to make Home Capital’s culture more innovative, and he expects to hire more staff who “speak [digital] as a first language.”
Outside his office hangs a painting of a crumpled piece of paper – a symbol of Home Capital’s long-term goal to be entirely paperless. For now, its style of mortgage lending relies heavily on teams of underwriters manually poring over stacks of documents.
The challenge now is to stay disciplined as competition for alternative mortgages heats up. Multiple new federal measures, including taxes on foreign buyers and tougher qualification rules for borrowers who take out uninsured mortgages, appear to have curbed increases in housing prices and dampened sales in major cities, such as Toronto and Vancouver. As a result, Home Capital has seen more intense competition for a smaller pool of loans among rivals such as Equitable Bank and Laurentian Bank of Canada, but also from other lenders, including credit unions moving more aggressively into the market. First National Financial Corp. recently reintroduced a program to issue near-prime loans and sell them to investors.
Private lenders and mortgage investment corporations have also sprung up with tens or hundreds of millions of dollars to lend. Anecdotally, Mr. Bissada says he thinks private lenders are gaining ground, and a June report by the Bank of Canada showed that private lenders boosted their share of new mortgages in the Greater Toronto Area to 8 per cent since 2017, mostly through short-term loans.
“We’re really playing a long game,” Mr. Bissada says. “We’re not, quarter by quarter, battling every competitor.”
In some ways, competition has made Home Capital less risky: Its average borrower now has a credit score above 700, up from 680 a couple of years ago, as applicants trickle down from large banks that are being more selective. More credit-worthy clients pay lower interest rates on mortgages, however, and that has squeezed Home Capital’s margins. Those same clients often take out loans with Home Capital, then switch to another lender as their credit improves.
There are also concerns about Home Capital’s unwieldy capital structure. Its common equity Tier 1 (CET1) ratio – a key measure of a firm’s financial buffer against bad loans – is much higher than industry norms, at 23.2 per cent. One shareholder, Kingsferry Capital Management Group Ltd., even publicly released a critical letter pressing Home Capital to buy back $60-million in shares.
Home Capital executives now say streamlining the firm’s capital is an urgent priority. But they must tread carefully under heightened scrutiny from Canada’s banking regulator, the Office of the Superintendent of Financial Institutions. As it stands, Home Capital is unlikely to announce its new capital plan until February at the earliest.
“We’ve had a number of shareholders say, ‘Well, that’s too long.’ We’ve had others that have suggested that they’re happy with the pace,” says Mr. Kotush, the CFO.
In the meantime, Home Capital must try to strike a balance between ambition and prudence. “We’ll be competitive,” Mr. Kotush says, “in a very responsible way.”