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Home Capital Group Inc. began suspending mortgage brokers after its board of directors received a letter from an anonymous whistle-blower last fall pointing it to problems with some of its mortgages, company officials confirmed Thursday.Brett Gundlock/The Globe and Mail

Home Capital Group Inc. began suspending mortgage brokers after its board of directors received a letter from an anonymous whistle-blower last fall pointing it to problems with some of its mortgages, company officials confirmed Thursday.

The company, which operates as one of Canada's largest alternative mortgage lenders through its subsidiary, Home Trust, revealed it hired an external investigator and launched a probe into its mortgages, finding evidence that some borrowers had submitted fake employment letters. In many cases, the borrowers actually worked at the companies listed in their mortgage applications, but claimed they made more money than they actually did, which allowed them to qualify for larger mortgages at better interest rates.

Home Capital said it ultimately cut ties with 45 brokers, the majority of whom worked for just two brokerages. In total, the brokers contributed more than $960-million to the company's mortgage originations last year, with the bulk of the business in the company's portfolio of insured mortgages.

In an interview, Home Capital chief executive officer Gerald Soloway said there was no evidence that any of the fraudulent mortgage applications involved people who were trying to defraud the lender. While the company has flagged all of the loans originated by its suspended brokers, none have defaulted and many are performing better than the company's overall mortgage portfolio, he said.

"These are not people who set out to get something, who didn't want to make the payments and comply," he said. "These are people who wanted a home and in order to facilitate it some of the documentation was not accurate. But the value of the home was accurate and the credit score was accurate and that's why they're performing so well."

The company could not say how many potentially fraudulent loans it has found so far, except that it is very small compared with its overall mortgage portfolio. It is working to go back and verify incomes for borrowers it has flagged and could potentially refuse to renew some of the mortgages when their terms are up.

Home Capital president Martin Reid said the company is confident that no employees were complicit in any mortgage fraud. That is a key factor in whether mortgage insurers such as Canada Mortgage and Housing Corp. will be willing to pay claims if any of the suspect mortgages default. The company has fired one or two "junior" employees in the wake of the investigation, Mr. Reid said, but added there is no evidence they were involved in altering documents. "There was disciplinary action taken where some [employees] were maybe not doing their job," he said in an interview.

The company's share price had been in freefall since it first warned in a July 10 statement that it would miss second-quarter results because it had cut ties with some of its mortgage brokers, although shares were up more than 13 per cent after its call with analysts Thursday.

Short-seller Marc Cohodes questioned why the company didn't disclose problems with its mortgage brokers earlier than July 10, given the company began cutting ties with brokers as early as last September. The Ontario Securities Commission requested Home Capital disclose more details about its investigation as part of its second-quarter earnings release on Wednesday. "All the way through this they were blaming origination shortfalls on the competitive nature of the market and being conservative, when in fact there was some form of whistle-blow on the fraudulent mortgages that were going through," he said.

Mr. Reid defended the company against criticism that it had waited too long to go public with the results of its internal investigation. "We feel our disclosure was appropriate," he said. "We met all the requirements. Perhaps when we did this disclosure on July 10 we probably could have provided a little bit more information to understand that."

Several analysts lowered their price targets on Home Capital, warning that even if the company's issues appear to be a short-term problem, they have shaken investors' confidence and will likely lead to slower growth this year.

"The operational weaknesses disclosed are embarrassing, but appear to have been addressed and the prospect of abnormal credit losses appears low," wrote Jeff Fenwick, director of institutional equity research at Cormark Securities Inc. "The question now is whether HCG can regain investor confidence and get back on track with driving growth."

National Bank Financial lowered its price target on the company to $31 from $36 on concerns that it will take Home Capital time to rebuild its broker network. "We believe the onus will be on HCG over the next 9 to 12 months to prove that credit losses on these mortgages will be modest and that the credit quality of the remainder of the portfolio remains sound."

The company has a long track record of conservative lending and emerged from the 2008 financial crisis stronger than many other alternative mortgage lenders in Canada, said Jeff Mo, portfolio manager at Mawer Investment Management Ltd., a long-time Home Capital investor. "Is management's credibility damaged because of this? I would say slightly, because you ideally would not have any operational issue, especially in the underwriting and origination side of the business," Mr. Mo said. "But does that mean we have lost faith or trust in management? No, I think the actions are exactly the type of actions we want the management team to take when dealing with an issue like this."

Mr. Soloway stressed that the company didn't believe problems with some of its mortgage applications would lead to significant losses, or seriously harm the company's long-term growth prospects. "I know people are concerned," he said, "but I don't think it will have any follow-on financial consequences for the company."

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