Home Capital Group Inc. was scrambling Friday to find a deal that would stabilize the company as investors continued to withdraw funds from their savings accounts.
The Toronto-based company is pitching a variety of financial institutions on a rescue package, but investment banking sources said the best possible price may come from breaking up the company and selling portions of its mortgage portfolio to regional financial institutions.
Home Capital is the country's largest alternative mortgage lender with $18-billion of home loans outstanding, a portfolio that would be difficult to swallow for rivals in the alternative mortgage sector, such as credit unions, small mortgage lenders, Montreal-based Laurentian Bank and Edmonton-based Canadian Western Bank. But these institutions, along with private equity firms, could still bid for pieces of Home Capital.
"The made-in-Canada solution for Home Capital would be to put the company's assets into stable hands, and those buyers will vary by region," one investment banker working with potential bidders said.
Private equity bidders could include New York-based J.C. Flowers & Co., which invests in financial services companies and entered the domestic market earlier this year by acquiring alternative lender Citi Financial, which had $2.5-billion in assets and 217 branches across Canada. Earlier this year, J.C. Flowers founder and CEO J. Christopher Flowers said he expected to expand the company's Canadian real estate lending business.
Canada's six big banks are notable for their absence on a list of bidders. Home Capital lends money to home buyers who have been turned down by the major banks and none of these institutions is expected to enter the alternative mortgage sector by acquiring the company. National Bank of Canada proactively called the equity analysts who follow the company this week to say it would not bid on Home Capital after being asked if it was a potential buyer.
The company's financial woes have mounted over the past week as depositors have pulled funds from savings accounts at subsidiary Home Trust. The company revealed Friday that high-interest savings account balances fell another 36 per cent to $521-million by Friday morning, down from $814-million Thursday and more than $2-billion a month ago.
Canada's banking industry regulator, the Office of the Superintendent of Financial Institutions (OSFI), has gathered data from other financial institutions this week, both to monitor for signs of a broader depositor panic and to track where funds are moving as they leave Home Trust.
OSFI sent an urgent request Wednesday to several smaller and mid-sized financial institutions and credit unions to provide the regulator with up-to-date information about their savings accounts, according to a source. Specifically, OSFI wanted to know the institutions' most recent account totals for high-interest savings accounts, as well as data on recent redemptions and current levels of high-quality liquid assets.
The request, to be fulfilled as soon as institutions are able, can be seen as an attempt to take the pulse of the market by tracking where deposits flowing out of Home Capital may be going, and to gauge whether there is any contagion among other institutions. In recent days, some smaller and mid-sized institutions have also struck up early-stage discussions about whether multiple institutions could join together to explore a deal to buy some of Home Capital's assets, a source said.
A spokesperson for OSFI said in an e-mail that the regulator "undertakes various supervisory activities" over the institutions it supervises, but is prevented by law from discussing that work.
While Home Capital's problems erupted this week, it is now clear that concerns about its stability have been percolating behind the scenes for months, creating a backdrop that left the company vulnerable to any signs of trouble.
Last November, Canaccord Genuity Group Inc. told its financial advisers they could no longer steer investors to high-interest savings accounts at Home Capital or rival alternative mortgage lender Equitable Bank. Client money already placed with either bank had to be moved within 60 days.
Canaccord said it was concerned about the risks mounting in the alternative lending sector, saying in an internal memo that the rate of interest on the savings accounts was no longer high enough to offset the risks of being exposed to Canada's overheated housing sector. The memo also said Canaccord was worried government mortgage constraints announced in October could cause new mortgage growth to decline.
Since then, more banks have taken similar steps. After Home Capital revealed in March it was under investigation by the Ontario Securities Commission over its disclosure practices, Canadian Imperial Bank of Commerce introduced a cap of $100,000 per client for purchases of Home Capital guaranteed investment certificates (GICs), which is the maximum level covered by Canada's deposit insurer.
A spokesperson from Royal Bank of Canada said that, "several weeks ago" the bank introduced a $100,000 cap on Home Capital GICs bought through a full-service broker, although there were no limits for purchases through the firm's discount brokerage.
Late last week, Bank of Nova Scotia said it would stop selling all GICs sold by Home Trust, but said Monday that policy was amended to a limit of $100,000. Bank of Montreal's brokerage unit also confirmed it has a $100,000 limit on Home Trust GICs but would not say when it went into force.
Several of the banks imposed their GIC caps last week after the OSC unveiled a series of allegations, accusing Home Capital and a number of current and former executives of making "materially misleading statements" to investors.
The OSC news shook investors, but the panic was heightened as news of the banks' moves to cap investor deposits slowly seeped through Bay Street in subsequent days, raising concerns that major financial institutions were pulling away from Home Capital.
There was a further spark to the powder keg.
Sources said that, behind the scenes, some short sellers who have been aggressively betting against Home Capital began calling financial advisers late last week to share information and speculation about major banks curtailing deposits with Home Trust, further stoking concerns about the firm's viability.
By Wednesday this week, when Home Capital publicly revealed it was seeking a $2-billion loan to backstop its sinking savings deposits, shareholders ran for the exits, driving down the company's share price by 65 per cent on Wednesday alone, and heightening the sense of panic.
"When you have a run on the bank, people get spooked and they sell and ask questions later," said a Bay Street investment banker. "It's investor psychology that takes over."
Home Capital's share price rebounded somewhat on Thursday after the company reported it had locked-in a new $2-billion line of financing from a lender, later identified as a syndicate led by Healthcare of Ontario Pension Plan (HOOPP), which is the largest investor in the group.
Jim Keohane, CEO of HOOPP, had been a director of Home Capital until Thursday, but said he stepped away from the boardroom on Tuesday to remove the conflict of interest when it became clear HOOPP might step in as a lender.
Mr. Keohane said Friday that he doesn't view the Home Capital investment as risky because the pension plan will be provided with $2 worth of mortgages as collateral for every $1 it lends to Home Capital.
"We take comfort from the underlying asset portfolio, so we are not looking at Home Capital as a credit," said Mr. Keohane in an interview with Business News Network television. He added that a correction in the housing market is not of great concern, since the values of homes would need to plummet by more than 65 per cent for the fund to make no return beyond the value of its principal commitment.
Mr. Keohane also said that the funding syndicate would rank above Home Capital's other lenders.
"We have security interest in the collateral we've received, so we have the right to sell that collateral if we don't get paid. And then the balance that's left over would go to recovery for other creditors."
When asked if Home Capital could survive this run on its deposits, Mr. Keohane said it was possible.
"I think it's a viable business," he said. "Their cost of funding is going to go up, which may impact earnings… it's always a possibility that some other institution may have an interest in taking the entity over. If you can have access to a lower funding cost, I mean, it's quite an attractive purchase."
Many investors are unwilling to wait and see whether things stabilize, however.
Late Friday, Home Capital's second biggest shareholder, Calgary-based QV Investors Inc. disclosed that it liquidated its position, selling 8.4 million shares. QV Investors previously held a 12.8-per-cent stake in Home Capital. Toronto-based Turtle Creek Asset Management Inc. is Home Capital's biggest shareholder with 13.6 per cent stake, according to Thomson Reuters data.
With files from James Bradshaw and Christina Pellegrini