Shares of beleaguered mortgage lender Home Capital Group Inc. plunged 65 per cent on Wednesday as the company revealed it was negotiating an emergency $2-billion line of credit to shore up its finances after depositors rushed to pull money from their savings accounts.
The news shook Bay Street as analysts raised concerns about the company's viability if investors continue to withdraw more funds from their accounts at Home Capital's wholly owned financial subsidiary, Home Trust.
Home Capital is Canada's largest alternative mortgage lender, providing subprime loans to people who don't qualify for traditional bank mortgages.
The company relies on deposits to provide the money to make loans.
Its financial struggles, which stem in part from a regulatory investigation in Ontario, underscore the pressure that is building in parts of the housing market.
Home Capital is one of a number of lenders that provide a path to home ownership for people who would otherwise find it hard to borrow money for a house. But at the same time, the company has come under scrutiny for what some critics say are lax lending practices that have added fuel to real estate prices.
Laurentian Bank analyst Marc Charbin said the announcement of withdrawals suggests deposit brokers "are losing faith" in Home Capital.
"Worst case, this could cause a run on the bank," he warned in a statement to clients Wednesday.
Analyst Jaeme Gloyn of National Bank Financial said the news "could spur other investors and deposit agents to continue redeeming high-interest savings accounts or demand deposits."
However, Home Capital said it is well capitalized. The company said the expected new line of credit, combined with Home Trust's current available liquidity, would give it access to more than $3.5-billion in total funding, which is more than twice the amount of the balances in the high-interest savings accounts.
"Access to these funds is intended to mitigate the impact of a decline in Home Trust's [high-interest savings account] deposit balances that has occurred over the past four weeks and that has accelerated since April 20," it said.
Canada's banking regulator, the Office of the Superintendent of Financial Institutions Canada (OSFI), said Wednesday it is "monitoring the situation closely."
Home Capital revealed Wednesday that depositors have withdrawn $591-million since March from their high-interest savings accounts, leaving a remaining balance of $1.4-billion.
"The company anticipates that further declines will occur, and that the credit line would also mitigate the impact of those," it said.
Home Capital did not reveal who it was negotiating with for the new borrowing facility, but said Wednesday it expected "a firm commitment would be agreed to later today."
Despite the drop in savings deposits, Home Capital said balances of its guaranteed investment certificates (GICs) have remained "essentially unchanged." As of Dec. 31, 84 per cent of Home Trust's deposits were GICs and other products payable on fixed dates, and 16 per cent were demand deposits such as savings accounts.
"Unlike the decline in high-interest savings [which depositors can withdraw at any time], Home Trust's GIC deposits mature over time and have remained stable in recent weeks," Home Capital chairman Kevin Smith said in an e-mailed statement.
Mike Rizvanovic, analyst with Veritas Investment Research, said the biggest fear is a possible run on the GICs.
"We don't know if the same thing is going to happen to the fixed deposits, but if it does," Mr. Rizvanovic said, "then this business cannot exist."
As the financial crisis of 2008 and 2009 demonstrated, financial-services companies are built on investor confidence. If confidence starts to slip, panic can quickly take over and cause stock prices to plummet in the blink of an eye. Over the past week, fears have grown that potentially put Home Capital's business model in jeopardy.
Home Capital's financial problems have been growing since March, when it revealed the Ontario Securities Commission was investigating the company's disclosures to investors. The company fired its chief executive officer shortly after.
Its troubles escalated last week when the OSC unveiled a series of allegations, accusing the company of making "materially misleading statements" to investors. The regulator also named a number of current and former executives in its allegations. Earlier this week, more impending top-level departures were announced, including the planned exit of its chief financial officer early next month.
But the most immediate problem for Home Capital has been a growing lack of support from other financial institutions, who steer clients into Home Trust's high-interest savings products. Roughly 70 per cent of Home Trust's total deposits are GICs placed by third-party brokers. Without those deposits, the company can't adequately fund itself – barring a massive bailout.
Most of Canada's biggest banks – including Royal Bank of Canada, Bank of Montreal, Bank of Nova Scotia and Canadian Imperial Bank of Commerce – have recently limited the amount of money their customers can invest in Home Trust's high-interest savings accounts and GICs to a maximum of $100,000, which is the amount insured by Canada Deposit Insurance Corp. (RBC's limit does not apply to clients who use its discount brokerage.)
Investors have interpreted the banks' caution as a lack of confidence in Home Trust's stability, and have liquidated Home Capital's shares, driving them down to their lowest level since September, 2003. Home Capital's market value fell from $1.1-billion Tuesday to just $384.6-million.
Mr. Charbin of Laurentian Bank said the GIC deposits may be vulnerable. GICs have fixed terms and there are penalties for early withdrawals, so investors have less flexibility to move them quickly. But they could "follow the same trajectory" as the high-interest savings deposits when they are renewable, he said.
Home Capital's new borrowing has not come cheap. It said the new credit line under negotiation would carry a 10-per-cent rate of interest on the first $1-billion borrowed, and 2.5 per cent on the remainder. The company will also pay a $100-million "commitment" fee, which is non-refundable.
The company warned the borrowing costs "would have a material impact on earnings, and would leave the company unable to meet previously announced financial targets."
Mr. Gloyn said that if Home Capital's planned funding materializes, it would be paying an effective interest rate of 22.5 per cent on its first $1-billion of borrowing, or 15 per cent if the company uses the full $2-billion facility. He said that could drive down 2017 profit per share by 20 to 40 per cent.