It was late in the evening on Sunday, April 30, when lawyers working for Home Capital Group Inc. dialled into a call with lawyers representing the company's new lending syndicate.
The troubled mortgage lender had negotiated a $2-billion credit line just days earlier, emergency money the board felt was needed to survive after a high-profile run on deposits at subsidiary Home Trust. The company planned to draw down the first $1-billion from it the next morning, May 1.
But the deal was getting bogged down in a last-minute dispute over details of the funding, according to two sources familiar with the talks. As the conversation proceeded late on Sunday, it became increasingly evident that the fate of the financing was hanging in the balance. Another call at 2 a.m. on Monday ended badly with no agreement, a source said.
There was no room for error. Home Capital was hours from the start of its business day, and it was critically low on capital. The board had determined the company could not open its doors for business Monday morning without the financing in place, the sources said.
As the dispute continued, officials from Canada's banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), were on standby to launch a process to take control of the company Monday, a move that would have almost certainly forced some form of wind-up of Home Capital's business, the sources said.
In the end, some time prior to 7 a.m., the lawyers hammered out a deal on final terms of the loan, allowing the first $1-billion to be transferred Monday. When business started a couple of hours later, only a small circle of exhausted insiders knew how close the company had come to collapse.
'It happened very fast'
Over the past three weeks, events at Home Capital have captivated Bay Street and policy makers in Ottawa and Toronto. The attention may seem outsized for a company that is such a relatively small player in Canada's lending market, but Home Capital dominates an important niche of the market, providing mortgages to people who are turned down by banks, including many new immigrants and self-employed workers.
But much of the unrelenting focus on the company is also due to the rarity of a financial institution failing in this country. Canada Deposit Insurance Corp. (CDIC), which insures deposits in the event of a bank failure, hasn't paid a claim since 1996.
The Globe and Mail has pieced together the story of Home Capital's scramble in recent weeks to cope with an escalating crisis of confidence, and the array of factors that led the company to the brink of collapse early in the morning on May 1.
Many commentators have pinpointed April 19 as a pivotal date when the Ontario Securities Commission unveiled an explosive enforcement case against the company and three of its executives, accusing them of making misleading disclosure to investors about mortgage underwriting problems in 2014 and 2015.
But if the OSC announcement sparked a conflagration at Home Capital, it was only because there was so much dry tinder already in place to ignite. The case landed amid a broader backdrop of concern about the company's financial condition, a loss of faith in senior management and the board, and extreme nervousness about the vulnerability of a non-prime mortgage lender deeply exposed to Toronto's overheated housing market.
Asked whether she blames the OSC for touching off the crisis Home Capital has faced over the past three weeks, Home Capital's new chair, Brenda Eprile – a former OSC executive director – said she does not. Indeed, Ms. Eprile said she still doesn't have a clear understanding about what caused a stable financial institution to unravel within days.
"I've heard various people say different things – I don't really know," she said in an interview on Friday. "All I know is that it happened very fast."
The runup to the run
For two months prior to the OSC announcement, concerns about Home Capital had mounted among investors over an unfolding series of events. Many of these matters played out quietly but were watched closely by analysts, major shareholders and a rabid group of short-sellers.
The first alert about the OSC case, for example, emerged late on a Friday afternoon on Feb. 10, when many had already left for the weekend.
Home Capital Group issued a two-paragraph release revealing it had received an enforcement notice from the OSC, relating to disclosures in 2014 and 2015 about an internal investigation that found information on some loan applications had been falsified, leading to suspensions of 45 mortgage brokers. The enforcement notice said OSC staff had reached a preliminary conclusion about problems at the company, but Home Capital still had an opportunity to respond before the commission decided whether to launch disciplinary proceedings.
The company's share price slid 6 per cent the following Monday as investors digested the news, but many hoped the company would quickly resolve the matter, with one analyst predicting there could be a negotiated settlement deal.
The February release also landed two days after the company had posted its less-than-stellar 2016 financial results, reporting a 14-per-cent drop in profit after expenses climbed 20 per cent last year.
In response to concerns about expense growth, CEO Martin Reid announced the company launched "Project Expo," a campaign to slash $15-million from its expense base during 2017 by targeting operating costs. Analysts, however, were particularly focused on the company's continuing inability to retain clients.
Home Capital had no trouble writing a growing number of new mortgages for non-prime borrowers in a hot housing market last year, but it also saw many of those customers leave at the first opportunity when their mortgages came up for renewal.
Borrowers at Home Capital typically sign on for one-year or two-year mortgages in the hopes of moving to a mainline bank with a cheaper lending rate once their credit history is established. That leaves Home Capital facing constant churn, analyst Jeff Fenwick of Cormark Securities said, making its retention data one of its most closely watched metrics.
Of the $13.3-billion in residential mortgages on Home Capital's books at the start of 2016, Mr. Fenwick estimates $6-billion or 45 per cent "rolled off" during the year – a rate of attrition far higher than faced by bank lenders, whose customers tend to opt for five-year mortgages.
"This is one disadvantage for a lender like Home – there is a consistent treadmill of origination activity that needs to happen in order to prevent the mortgage book from shrinking," he said.
In a statement in February, Mr. Reid said the attrition rate was disappointing, telling analysts that performance in 2016 was "muted" by lower-than-expected renewals. He said improving retention would be a priority in 2017.
The financial results on their own would not have been a major concern, but they also came as worries were mounting about Toronto's housing market.
Through February and March, investors were growing increasingly jumpy about the prospect of a housing bubble in the Toronto market as home prices climbed over 30 per cent compared with a year earlier. Major bank economists began warning about a housing bubble and even normally reserved bank CEOs began to voice their concerns about excessive speculation in the market.
For investors watching for signs of a possible trouble in the housing market, Home Capital was a particular focus because it is an alternative or "near-prime" lender, whose customers don't qualify for mortgages at major banks.
A CEO departs
Of the many moves that laid the groundwork for the run on the bank at Home Trust in late April, the company's decision to terminate Mr. Reid on March 27 has emerged as a particularly critical moment.
Mr. Reid had only stepped into the CEO job in May, 2016, after the retirement of company founder Gerry Soloway. (Independent director Bonita Then was appointed interim CEO, but she was unknown to most analysts.) In a news release issued in the early evening on March 27, the company vaguely announced it wanted new leadership that could "bring to bear a renewed operational discipline."
The information vacuum frustrated investors and allowed speculation to mount about what was happening behind the scenes, and whether Mr. Reid's departure was linked to the OSC investigation or other major problems. During the decade Mr. Reid spent at Home Capital, he had earned a reputation as a thoughtful leader, and Mr. Soloway supported his appointment as CEO, according to a source familiar with company management.
But once Mr. Reid took over, the board – which was used to having a strong, entrepreneurial founder CEO at the helm – came to think Mr. Reid was taking too long to consider and make decisions. With Home Capital under review by the OSC in late March, the board felt it was time to bring in a new CEO who could take bolder action.
Whatever the reasons for his departure, the news spooked investors more than any announcement in the prior month. The company's share price fell 10 per cent on the day following the evening announcement, and continued to slide even lower in the two subsequent days.
The short-sellers pounce
That same day investors were reacting to news of Mr. Reid's departure, Canadian Imperial Bank of Commerce made a decision that would prove important, at least in hindsight.
The bank issued an internal directive to financial advisers on March 28, telling them to limit their clients' exposure in Home Trust's GICs to the $100,000 limit insured by Canada Deposit Insurance Corp. The decision meant financial advisers had to shift assets above that cap to other institutions.
Around the same time, Royal Bank of Canada made a similar move for clients of its full-service brokerage division. Bank of Montreal also imposed caps, but will not say when it introduced the limits.
Home Capital would later disclose that savings account withdrawals began to mount at the end of March, around the same time that these policies were implemented.
During the same period, short-sellers moved into overdrive to fan fears about Home Capital, while filling social-media sites with speculative claims and half-truths. Short-sellers, who bet that a company's share price will fall, have targeted Home Capital aggressively since the summer of 2015, making it consistently one of the most-shorted companies in Canada.
An example of their influence was evident on April 13, when shares of Home Capital fell by up to 8 per cent in a single day, despite no apparent news about either company. Home Capital believed the decline was sparked by inaccurate social-media comments claiming Bank of Montreal and Bank of Nova Scotia had issued directives to its advisers to stop buying Home Capital's GICs. Such a move would have been major news because the lender relies on deposits to provide the capital to run its mortgage-loan business.
The company told analysts the claims were untrue, and analysts at National Bank of Canada said they double-checked with other financial institutions and found they were still offering the GICs, at least for full-service clients.
But the fact that unproven claims published by dubious sources could so significantly move Home Capital's share price was evidence of the nervousness surrounding the company.
"The short-sellers to their credit were enormously successful in raising fear," said a Toronto-based fund manager who held Home Capital shares. "If the short-seller's job is to sow fear and confusion, they were very successful in doing it."
The company also saw the stream of inaccurate rumours swirling, but could do little to stop the shorts.
"They have their own vested interests, and so they've got their agenda, which they're trying to promote," Ms. Eprile said. "It is a frustration."
It was amid this worry, less than a week after the April 13 share price drop, that the OSC unveiled its allegations in the evening of April 19.
While many of the main issues laid out in the statement of allegations had been previously disclosed by Home Capital, there were new details about the volume of material the company had collected in an internal investigation into its mortgage loan problems from mid-2014 to early 2015, but had not reported publicly until July, 2015, when pushed by the OSC to provide disclosure to investors.
When markets opened the following morning, April 20, Home Capital's share price began to crater.
A key concern was that the release came just hours before the Ontario government unveiled a series of measures to cool off Toronto's housing market on the morning of April 20, including imposing a new 15-per-cent tax on foreign buyers. The combination of both was seen as a double-whammy, hitting Home Capital at a vulnerable time in the housing cycle.
For its part, the OSC said it does not co-ordinate with the province on the timing of enforcement cases, and the province does not consult with the OSC on other initiatives.
"We are not privy to the province's plans regarding budgetary policy and legislation," spokeswoman Kristen Rose said. "We also do not discuss ongoing enforcement matters with the province."
The news of the OSC allegations, combined with the new housing measures, drove Home Capital's shares down by over 20 per cent on Thursday, April 20, and spurred more institutions to start limiting deposits with Home Trust, most notably Bank of Nova Scotia.
On the morning of Friday, April 21, as investors scrambled out of Home Capital shares, a message popped up on financial advisers' computer screens at Scotiabank. It was an internal notification from ScotiaMcLeod head Rob Djurfeldt, announcing that as part of an "ongoing review of 3rd-party products," the bank would no longer allow the sale of Home Trust GICs.
While some other banks had already limited sales of Home Trust products to the $100,000 CDIC cap, the memo suggested Scotiabank was going even further to cut off sales entirely. It was taken by many – including Home Capital itself – as a signal of a loss of faith in the company.
Over the subsequent weekend, however, Scotia abruptly changed course and put Home Trust back on its platform with a $100,000 limit per client.
Some players in the market jumped to their own conclusions that a regulator was involved in the reversal.
"When Scotia dropped Home Trust on a Friday, only to put them back on the following Monday, everyone connected the dots," that regulators were involved somehow, said Lee Matheson, managing director with Toronto-based hedge fund Broadview Capital Management Inc., which has had a short position in Home Capital for the past 18 months.
However, Scotiabank spokeswoman Debra Chan said the company made its own decision internally to reverse course. "The decisions related to selling GICs were business decisions made independently by us," Ms. Chan said. "We cannot speak on behalf of OSFI and any question related to them is better directed to them."
Alex Besharat, senior vice-president at Scotia Wealth Management Canada, was part of the discussions held internally at Scotia that weekend about whether to put Home Trust's GICs back on its platform. "There was a lot to that decision – it wasn't just sort of a one-dimensional decision," he said in an interview.
OSFI turned down multiple requests for comment, saying it is prohibited from commenting on institutions it supervises or its supervisory work.
By Monday morning, April 24, Home Capital was facing a raft of withdrawals from depositors.
The public nature of Scotiabank's move was part of the reason for the rush, with Home Capital itself announcing Monday morning that the bank had put its products back onto its platform.
The announcement served to ensure any financial advisers still unaware that other banks had quietly limited client exposure weeks earlier were now fully aware of at least one major bank's moves to cap deposits at Home Trust.
Many brokers and financial advisers quickly moved client funds to other institutions, unwilling to jeopardize their deposits for a slightly higher interest rate offered by Home Trust's high-interest accounts.
Home Capital officials watched the pace of client withdrawals climb quickly on Monday, and decided they needed to do more to reassure the markets. That same day, the company announced that Mr. Soloway – Home Capital's founder, who had remained on the board after stepping down as CEO in 2016 – would depart entirely as a director "when a replacement with recognized expertise in financial services is named." However, the company said Mr. Soloway would still stand for re-election at the annual meeting, which was then scheduled for May 11, but has since been delayed until June 29.
It also announced Mr. Morton would step down as CFO, but only after the first-quarter financial results were filed. He would take on a new role as head of special projects, and would be replaced by Robert Blowes as interim CFO.
Board chair Kevin Smith said the changes were aimed at rebuilding market confidence in the company. But the moves were again too little, and too late.
On Wednesday, April 26, the company made its first disclosure to alert the markets about the run on Home Trust's savings accounts, saying deposits in high-interest savings accounts were down by almost $600-million to $1.4-billion from $2-billion at the end of March.
The announcement sparked a far broader panic, and was the first indication that many in the public had of the size of the company's problems. Savings account withdrawals would accelerate rapidly through the subsequent days, leading to a classic unstoppable run on the bank caused by depositor panic.
The company most recently revealed Home Trust has just $125-million left in its high-interest savings accounts, a decline of over 90 per cent since late March.
Canada hasn't seen a run on a bank such as this in decades, and many in the current crop of regulators have no personal experience dealing with the sort of crisis that unfolded in late April at Canada's largest alternative mortgage lender.
A source said regulators began co-ordinating discussions "early on" in the crisis, before Home Capital was front page news, but no one anticipated the company was so vulnerable. Last summer, OSFI had no concerns with the company's capital levels, liquidity or stress test results, according to another person familiar with the matter.
But as the week of April 24 progressed, regulators grew worried they may not be able to halt the company's slide.
At one meeting involving officials from OSFI, CDIC and the federal finance department, there was discussion that Home Capital could collapse by early May, based on the pace of withdrawals and its remaining capital, the source said.
Participants even discussed a scenario where Home Trust could fail, which would require Finance Minister Bill Morneau to sign an order giving OSFI control of the bank, the source said.
No regulator has agreed to comment publicly about Home Capital, but behind the scenes sources say procedures quickly kicked into place, if not always in perfect harmony.
In the first two weeks of the crisis, top leaders and their staff – including OSFI, the Bank of Canada and Canada Deposit Insurance Corp. – were on the phone "every hour" to discuss their response, the first source said.
At one point, a meeting at one regulator's headquarters was interrupted repeatedly as officials left the room in a steady stream to answer urgent calls about Home Capital, the source said.
A focus of regulators has been on ensuring Home Capital remains "orderly," the two sources said, and especially that there is no contagion to other institutions, including other specialty lenders such as Equitable Bank.
Key regulators who monitor system risks in the financial system – including the federal finance department – have also held Sunday morning conference calls to discuss plans for the week ahead, with the heads of the organizations typically on the calls.
A lifeline from HOOPP
As worries grew that the company could be facing imminent collapse, Home Capital needed a lifeline, and turned to what would prove to be a controversial solution.
The company negotiated a new line of credit led by the Healthcare of Ontario Pension Plan, a pension fund whose CEO, Jim Keohane, also sat on the Home Capital board.
Critics were shocked by the crippling terms of the loan. Home Capital agreed to pay 10-per-cent interest on the drawn portion of the credit line and 2.5-per-cent interest on unused balances, as well as an up-front, non-refundable fee of $100-million to secure the loan. On the first $1-billion that would be drawn on May 1, the effective interest rate was 22.5 per cent, factoring in the commitment fee.
The loan was also backed by up to $5.4-billion of Home Capital's mortgages, the company would later reveal.
The HOOPP loan sent all the wrong signals. For many in the financial community, the onerous terms were seen not only as an anchor around the company's neck, but even as a signal from HOOPP that Home Capital's finances must be worse than anyone knew if this was the best possible deal.
Many believe the loan was negotiated too hastily by a board that lacked the connections or clout to find a better deal on better terms. One source close to the company said the board appeared to have "panicked" while another said the board "malfunctioned" due to a lack of sophistication and expertise.
Ms. Eprile said she knows the board has been criticized for the terms of the deal, but directors took the best possible offer at that time.
"Every option was explored in the circumstances and it was the best option for us to go with," she said. "It wasn't the only option – it was the best option. And the board, I think, acted very responsible."
A funding option foregone
As the board was taking steps to negotiate the HOOPP loan, a senior Canadian banker came forward with another offer, according to a source involved in the financing.
The offer included a $2-billion line of credit backed by Canada's largest banks, at a much lower interest rate, along with a proposed candidate for a new CEO and proposed new board candidates. But the source said the offer came when Home Capital was late in negotiations with HOOPP, and it was not guaranteed.
Ms. Eprile said she could not discuss other funding options, "but this [HOOPP loan] was the best option at the end of the day, so we went with it," she said.
Faced with a rapid run on deposits, and with strong ties with HOOPP's CEO, the board decided to lock in the deal on the table.
The company moved quickly to use the HOOPP financing. Early on Monday, May 1, Home Capital needed to make the first drawdown on its HOOPP line of credit, initially seeking $1-billion of the credit line.
Late Sunday evening, however, lawyers began to fight over details of the agreement and the money was not immediately transferred. During the delay, company officials feared they may not have been able to open for business that morning with no financing to conduct any operations.
Ms. Eprile would not discuss the events of that Sunday in detail, but said everyone was working "around the clock" throughout that period, and she was sleeping with her cellphone during those days as she awaited news of developments.
"Crises have lots of twists and turns, and this one did too, but we got through it," she said. "We got the short-term [HOOPP] funding, which was fantastic, and we live to fight another day."
A clean sweep
While Home Capital spent the first week of its crisis scrambling to respond to the run on its deposits, it spent the second week on two priorities: putting a new board of directors in place and securing a better source of additional financing.
Home Capital quickly announced four senior business executives would join its board as part of a "governance renewal." They included Claude Lamoureux, former CEO of the Ontario Teachers' Pension Plan, and Alan Hibben, a former Royal Bank of Canada executive with long experience restructuring troubled companies.
Mr. Hibben said he previously knew two of the other new directors – Paul Haggis and Sharon Sallows – because they had worked together at Bank of Montreal earlier in their careers. Ms. Sallows knew Mr. Lamoureux because she had previously sat on the Teachers board.
To complete the clean sweep, the company also announced Mr. Smith would step down as chair of the board, and independent director Brenda Eprile would become chair. Mr. Smith will remain an independent director.
The company also announced a deal this week to sell up to $1.5-billion of new mortgages as it originates them. The deal will be facilitated by mortgage finance firm MCAP Corp.
The company's next move will be to replace the HOOPP loan with more affordable funding. The terms of that loan allow the company to repay the credit line whenever possible, and the company has hired investment bankers to explore different funding options.
Ms. Eprile said a committee of the board is also actively talking to new CEO and CFO candidates as one of the next top priorities.
She said she feels "a real sense of optimism" that Home Capital is now stabilizing, especially after strong new directors like Mr. Hibben joined the board last week and immediately rolled up their sleeves to tackle a host of issues.
"There's a real sense that we can make it," she said. "We just have to be very hunkered down and do our plan, and the company can be restored to a very positive future."
A timeline of the Home Capital saga
May 6: Home Capital Goup Inc. issues solid first-quarter earnings, but reports a drop in mortgage originations (new mortgages). The company cites "a traditionally slow real estate market exacerbated by very harsh winter conditions," and refers to "ongoing reviews of its business partners ensuring that quality is within the company's risk appetite."
July 10: Home Capital reports a continued slowdown in mortgage originations for the second quarter of 2015. The company says the causes included the suspension during September, 2014, to the following March of the company's relationship with 18 independent mortgage brokers and two brokerages, for a total of 45 mortgage brokers. The price of HCG shares drops 19 per cent the next day.
July 29: Disclosing more information about the terminated brokerage relationships, Home Capital says that in late 2014, an external source alerted Home Capital's board to possible discrepancies in income verification information submitted by certain mortgage brokers. An investigation determined that falsification of income information had occurred.
Feb. 29: Home Capital says Gerald Soloway will retire as CEO, and names president Martin Reid as his successor.
Nov. 10: Canaccord Genuity Group Inc. tells financial advisers in a memo they should no longer steer investors to high-interest savings accounts at Home Capital or rival alternative mortgage lender Equitable Bank. Canaccord says it was concerned about the alternative lending sector, saying 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.
Feb. 10: Home Capital discloses it received an enforcement notice from the Ontario Securities Commission on Feb. 9 relating to the company's disclosure in 2014 and 2015 regarding the company's internal findings that some income information had been falsified and the suspension of brokers. The notice indicates the OSC found Home Capital failed to meet its disclosure obligations.
March 14: Home Capital says the OSC subsequently issued enforcement notices to several current and former officers and directors of the company relating to the disclosure and in some instances trades in the company's shares. The company says its disclosure satisfied applicable requirements.
March 27: Home Capital says Martin Reid has been terminated as president and chief executive officer, and names director Bonita Then as interim president and CEO.
March 28: CIBC sets a $100,000 per-client cap on GICs from company subsidiary Home Trust.
March 28: Home Capital has a balance of about $2-billion in its high-interest savings accounts, but investors soon begin pulling money out.
April 19: OSC files extensive statement of allegations against Home Capital, Gerald Soloway, Robert Morton and Martin Reid. OSC says: "From Feb. 2015 until July 2015 HCG misled its shareholders as to the immediate and on-going causes of the decline in originations. Internally, HCG knew it had terminated certain brokers because it had discovered fraud in HCG's broker channels."
April 20: Shares drop 20.6 per cent on the OSC news. National Bank analyst Jaeme Gloyn says the OSC allegations "could cause material damage to the company's reputation," and raises concerns about a possible downgrade of the company's debt, weaker funding capabilities and softer loan growth.
April 20: Ontario unveils 16 measures aimed at cooling the housing market, including a "non-resident speculation tax."
April 21: Home Capital pre-announces first-quarter earnings, saying it expects earnings of $0.90 a share and cites "strong results in the company's core residential mortgage business." Home Capital chairman Kevin Smith writes: "We remain confident about the company and its future" and "the business is robust and on the right track," adding: "I recognize that we have had our fair share of challenges and the confidence of our stakeholders has been understandably shaken."
April 21: Bank of Nova Scotia, citing "a review of third-party products," stops selling Home Trust GICs.
April 24: Home Capital announces Gerald Soloway will step down from the board. CFO Rob Morton is sidelined. Bank of Nova Scotia resumes sales of Home Trust deposit products subject to a $100,000 per-client cap.
April 24: Royal Bank spokesperson says "several weeks ago" the bank set a $100,000 per-client limit for Home Trust GICs through its full-service brokerage. Bank of Montreal's brokerage unit says it also has $100,000 limits on Home Trust GICs, but will not say when that went into force.
April 26: Home Capital shares plummet 65 per cent when the company for the first time reveals plunging deposits and efforts to secure a $2-billion emergency line of credit. The company says its savings-account balance dropped $591-million to $1.4-billion from March 28 to April 24, having accelerated since April 20. The $2-billion credit line "with a major institutional investor" has onerous terms: a $100-million upfront commitment fee, an initial draw of $1-billion and an interest rate of 10 per cent, plus a standby fee of 2.5 per cent on undrawn funds.
April 27: Home Capital secures the line of credit and says it has retained RBC Capital Markets and BMO Capital Markets to advise "on further financing and strategic options." Jim Keohane, president of the Healthcare of Ontario Pension Plan, which provided the $2-billion line of credit, resigns from Home Capital's board.
May 1: Initial drawdown of $1-billion from line of credit.
May 5: Former RBC managing director of mergers and acquisitions Alan Hibben named to the board, replacing Gerald Soloway.
May 8: Three new board members appointed, including Claude Lamoureaux, former CEO of the Ontario Teachers' Pension Plan. Corporate director and risk consultant Brenda Eprile is named chair, replacing Kevin Smith, who remains on the board. Company says $1.4-billion of $2-billion credit line has been drawn down as Home Trust savings account balances drop below $200-million.
May 9: Home Capital announces plan to sell $1.5-billion of mortgage commitments and renewals to an unnamed buyer, later identified by The Globe as MCAP, to help boost liquidity.
May 11: Home Capital warns of "material uncertainty" about its ability to secure funding in the future. Savings account balances drop to $128-million.