Home Capital investors weigh costs of Buffett bailout

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Can Home Capital Group Inc. have too much of Warren Buffett?

The beleaguered mortgage firm is basking in the moment after the renowned investor's Berkshire Hathaway Inc. agreed to extend $2-billion in credit and take a hefty equity stake.

Home Capital shares, which plunged below $6 earlier this year when it looked as if the company might not survive, ended the week at $18.61 – thanks in part to the Buffett Bump.

At that price, Mr. Buffett already sports a paper profit of $344-million on the 40 million shares that Berkshire agreed to buy. Now the question is whether Home Capital's other shareholders will let him keep all of it.

Under the deal's terms, a Berkshire subsidiary will first acquire a stake of nearly 20 per cent in Home Capital, or 16 million shares, at just $9.55 a share.

The Toronto company is relying on a so-called "financial hardship" clause to bypass a shareholder vote on that part of the transaction, giving it $153-million in fresh capital by the end of next week.

But a second, bigger share purchase by Berkshire – about 24 million shares, priced at $10.30 each – will be subject to investor approval at a special meeting in September. And it's not yet clear that Mr. Buffett's fellow shareholders will go along with it. If they do, Berkshire would wind up owning 38.4 per cent of Home Capital.

One investor who isn't convinced is David Taylor, chief investment officer at Toronto's Taylor Asset Management Inc. "We wouldn't vote for that, no. We're very happy with the first deal for 16 million shares, but we don't need any more than that," he said.

"I don't think getting more of Warren Buffett is going to make much of a difference with respect to adding any more credibility than he already has by owning 20 per cent," Mr. Taylor said. He says his firm, which manages about $1-billion in assets, holds roughly 5 per cent of Home Capital's shares.

Home Capital reached the financing deal after months of grappling with a crisis of market confidence and a run on its deposits. The problems stemmed from a case filed by Ontario securities regulators alleging a failure by Home Capital to disclose concerns about mortgage fraud.

After losing more than $1.8-billion in deposits from its high-interest savings accounts – and using an emergency credit line to stay afloat – the lender's board sought a financial partner with a strong reputation to help restore trust in its operations and attract new depositors. Few backers could have added more clout than the Oracle of Omaha, and the market cheered his arrival on the scene – even though the deal dilutes existing shareholders with deeply discounted stock.

Still, how much should the Buffett brand be worth?

Even Mr. Buffett has considered the prospect that shareholders may not approve his second wave of investment. "If it had been totally key to it, we could have made a whole bunch of things contingent on it, and we didn't do that," he told The Globe and Mail in a phone interview on Thursday.

"The board could only sell us the amount of shares they sold us [the first 16 million] without a shareholders vote, and we essentially acquiesced with that," Mr. Buffett said. "We hope the shareholders vote yes, but if they vote no, you know, we'll be going ahead with everything we promised to do." Home Capital's board has pledged to support the arrangement.

Whether or not Home Capital needs the second investment from Berkshire, which would provide it with an additional $247-million, may depend on what kind of financial state it is in by September and whether it can get cheaper sources of debt funding through savings accounts and guaranteed investment certificates (GICs).

Finance Minister Bill Morneau said that Home Capital's "private-sector solution to its particular issues" was a step in the right direction. "Now it will be up to them to prove to Canadians – whether they are seeking a mortgage from them or putting deposits there – that they will be a sound, long-term organization," he said.

Analysts said that Mr. Buffett's backing of Home Capital would likely lead to a marked increase in deposit flows and a more stable funding base.

"The Buffett endorsement more than offsets the materially dilutive share issuance required to obtain such a renowned corporate sponsor," said Jaeme Gloyn, analyst with National Bank Financial.

"Despite our more optimistic outlook as noted above, we believe the shares are currently pricing in too much upside at this time," Mr. Gloyn said in a note to clients.

Not all shareholders have reservations about ceding more equity value to Mr. Buffett.

For investors that intend to be long-term holders of Home Capital stock, the increased Berkshire stake would be beneficial, said Hugo Chan, who runs Shanghai-based Kingsferry Capital, which manages $150-million (U.S.) on behalf of global clients. The firm first invested in Home Capital after the stock plunged in April and Mr. Chan estimates that he now owns about 3.5 per cent of its outstanding shares.

"Berkshire Hathaway having more skin in the game is actually, I think, good for Home Capital's long-term potential," said Mr. Chan.

Mr. Chan said that he's observed some market speculation that shareholders would not broadly vote in favour of the second investment, but he said he sees value in Berkshire maximizing its equity stake in Home Capital. "I think 38 per cent would be quite a substantial stake and would tell us that Berkshire Hathaway wants to be in Home Capital for the long run," he said.

With a file by Bill Curry