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Signage for Home Trust Co., a subsidiary of Home Capital Group Inc., stands outside the company's headquarters in Toronto, on Thursday, May 4, 2017.

Cole Burston/Bloomberg

Home Trust Co., the main operating subsidiary of troubled alternative mortgage lender Home Capital Group Inc., is beefing up its anti-money-laundering controls under orders from Canada's banking regulator.

Toronto-based Home Trust, which offers mortgages, credit cards and deposit products to thousands of customers across the country, was put under heightened scrutiny by the Office of the Superintendent of Financial Institutions starting in late June, 2015, according to a person familiar with the matter who spoke on condition of anonymity because the person is not authorized to speak to the media.

In doing so, OSFI issued a warning to the lender about problems with its anti-money-laundering compliance procedures and its risk-management practices, that person said.

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Investigation: Mayday at Home Capital

That intervention process, known as staging, is triggered when OSFI formally instructs a financial institution to fix a significant problem.

When a lender is staged, it is given a rating ranging from one to four, depending on the severity of the issue, according to a document on OSFI's website. OSFI uses its discretionary powers, including imposing restrictions on a staged lender, to oversee the remedial action.

The staging process that began in 2015 is OSFI's third such intervention at Home Trust in about 12 years focused on weak anti-money-laundering controls. It was never disclosed to the public, as both OSFI and the lenders it supervises are prohibited from making such disclosures.

Those confidentiality provisions, outlined in federal statutes, keep consumers and investors in the dark when a company is in crisis.

Confidentiality provisions shield regulators and lenders from public scrutiny on certain matters, though part of the rationale for them is to minimize the likelihood of depositor runs that would destabilize financial institutions.

Parent firm Home Capital, which is Canada's largest alternative lender, has faced a crisis of confidence in recent months, including a run on its deposits, in the wake of an Ontario Securities Commission probe into the company's disclosures about its mortgage business. The flight of capital has caused the lender to lose about $1.8-billion in deposits from high-interest savings accounts since the end of March. The pace of withdrawals accelerated in April after the OSC disclosed detailed allegations against Home Capital as part of a separate regulatory probe, accusing the company of misleading investors about why it was originating fewer mortgages.

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The OSC allegations had the effect of spooking major investment firms, making them leery of putting customer money in Home Capital deposit products. The confluence of events has left the alternative lender mulling various strategic options, including a sale, as it seeks new consumer deposits to shore up its funding base. The Globe and Mail reported last week that a number of private-equity firms have put forward preliminary proposals to buy or recapitalize the company.

OSFI's review of Home Trust's anti-money-laundering compliance comes at a time when Canada is facing international pressure to combat financial crime. Last year, the Financial Action Task Force (FATF), an intergovernmental body, identified gaps in Canada's anti-money-laundering regime, including heightened risks in the real estate sector such as mortgage fraud. The FATF, which urged more supervision of the real estate industry, noted that organized crime groups involved in mortgage fraud launder money through banks, money service businesses, trust accounts and other businesses.

OSFI's staging of Home Trust does not mean the lender is complicit in any money-laundering – only that, in the regulator's view, its controls for preventing such activities are not as strong as they need to be. Generally speaking, regulators require lenders to weed out risky customers, keep proper records and report suspicious transactions.

Home Trust is not the only domestic lender to run afoul of regulators due to weak anti-money-laundering controls. OSFI recorded 72 failures of anti-money-laundering controls at Canadian banks between 2009 and 2014 alone, according to a 2015 story in The Wall Street Journal that cited a document released under the Access to Information Act.

Last year, Manulife Bank, a subsidiary of insurer Manulife Financial, paid a $1.15-million penalty to the Financial Transactions and Reports Analysis Centre of Canada (FinTRAC) for "administrative reporting lapses." FinTRAC is the federal anti-money laundering watchdog and enforces the Proceeds of Crime (Money Laundering) and Terrorist Financing Act. Separately, Bank of Nova Scotia and Bank of Montreal were ordered by U.S. regulators to fix deficiencies in their respective anti-money-laundering controls in recent years, according to public disclosures.

OSFI's current staging is linked to Home Capital's discovery in 2014 and 2015 of mortgage-documentation fraud in its broker channels relating to income verification for mortgage applicants, the person said. The falsifications triggered concerns that Home Capital's principal operating arm, Home Trust, was fuelling its growth in part through lending practices that could have enabled the circumvention of federal anti-money-laundering and anti-terrorist financing regulations in addition to OSFI's mortgage underwriting rules, that person added.

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In addition to faulty income verification, OSFI's anti-money-laundering concerns centred on Home Trust's monitoring of the roughly 6,440 tainted mortgages that it had uncovered by early 2015, that person said. Home Trust was instructed to take a close look at the gifts of cash some customers used to fund their down payments, the person added.

OSFI's mortgage underwriting rules, known as the B-20 guideline, require lenders to determine the source of down payments. OSFI also raised concerns about Home Trust's risk-management practices, including its handling of credit risk, and oversight by the company's board of directors, that person said. The regulator was also concerned about risks with the lender's business model, including its reliance on deposits gathered by brokers and its dependence on the Ontario market. At the end of last year, 84 per cent of Home Capital's mortgage and loan portfolio was to customers in the province, exposing the company to risks associated with high property prices in the booming Greater Toronto market.

Other concerns centred on the risk profile of the alternative lender's core client base, which is composed of customers who don't qualify for home loans from major banks, that person added.

Home Capital, in response to OSFI's concerns, made a number of changes, including adopting a new charter for the board of directors and adding new directors to beef up corporate governance, the person said. For instance, Brenda Eprile, a former senior partner specializing in risk at PricewaterhouseCoopers, became an independent director of Home Capital in 2016, but was elevated to board chair earlier this year.

"I agreed to join the board of Home Capital in 2016 and to become the chair in 2017 because I believe in the fundamental business premise of Home Capital, which is to assist home buyers, many of whom are new Canadians, to obtain mortgage financing and achieve their dreams of home ownership," Ms. Eprile said in an e-mailed statement provided by a spokesman.

Home Trust also overhauled its internal processes to better connect mortgage originations with the underwriting of those loans. The lender improved the quality-assurance functions within its compliance department and established performance management frameworks, that person added.

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"As the prudential regulator of Canadian financial institutions, it is OSFI's job to actively monitor and provide ongoing feedback to all financial institutions regarding their business and governance," Boyd Erman, an external spokesman for Home Capital, wrote in an e-mailed statement.

"It would be illegal for us or for OSFI to directly or indirectly disclose those communications or provide you with any details regarding any discussions with OSFI. However, we can confirm that we have always responded to and addressed any issues raised by OSFI and we have a very good working relationship with OSFI," he added.

When asked if the lender made a number of changes – including to its internal processes and corporate governance, in response to OSFI's concerns – Mr. Erman stated: "Following the suspended-broker situation that took place more than two years ago, the company proactively reviewed and overhauled multiple internal processes to strengthen compliance and to create a more robust risk and control framework."

In a separate written statement, OSFI said that "pursuant to its statutory confidentiality obligations, OSFI does not disclose supervisory actions about any of the institutions it supervises." Spokeswoman Annik Faucher also said that "financial institutions regulated by OSFI are prohibited from disclosing such information except in the limited cases permitted in the regulations, and on the condition that the information remains confidential."

Separately, Home Capital is facing allegations from the OSC that it, along with three former top-level executives, made misleading public disclosures about a slowdown in its mortgage originations as it strengthened its underwriting standards and took other steps to stamp out mortgage fraud. (One of the three executives, former chief financial officer Robert Morton, remains with the company in a reduced role.) Home Capital has previously said its public statements satisfied applicable disclosure requirements.

"The OSC is not privy to information about OSFI's supervisory activities," OSC spokeswoman Kristen Rose said in an e-mail. "We also cannot comment on legislation administered by another regulator or agency. With regards to anti-money-laundering matters, please note that these fall under federal jurisdiction," she added.

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This isn't the first time that OSFI has staged Home Trust to fix compliance and risk management deficiencies, according to two people familiar with the matter. The lender was the subject of a similar regulatory intervention during a period spanning 2005 to 2009, due to ineffective anti-money-laundering compliance and credit-risk issues, one of those people said. Pressure to shore up those controls intensified during the global financial crisis, with OSFI stepping up its supervision of the lender at that time, the second person said.

But about two years after that remedial process concluded, the regulator once again intervened at Home Trust over compliance issues. Between late 2011 and early 2014, OSFI staged Home Trust for a second time; zeroing in on anti-money-laundering and anti-terrorism financing deficiencies in addition to concerns about oversight by the board of directors, the first person said.

Home Capital declined further comment for this story. "As already noted, it would be illegal for us or for OSFI to directly or indirectly disclose the communications we have had with OSFI or provide you with any details regarding any communications with OSFI," Mr. Erman said.

FinTRAC declined to comment on whether OSFI had ever shared the details of its staging review of Home Trust with its officials, and would not disclose whether it has examined Home Trust for compliance failures on anti-money-laundering rules. FinTRAC and OSFI conduct concurrent reviews of financial institutions, but OSFI has much broader supervisory powers.

"Under the legislation, FinTRAC cannot comment on compliance actions it may have undertaken regarding specific entities subject to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act," spokesperson Renée Bercier said in an e-mail.

As part of its current OSFI staging process, which began nearly two years ago, Home Trust hired outside consultants to fix its compliance problems and has taken a number of steps to fortify its controls. For example, an independent team was established to confirm employment checks for all borrowers.

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Professional services firm KPMG was also hired to conduct a third-party review of the company's internal investigation into document fraud, known as Project Trillium. By early 2015, more than 6,400 compromised mortgages had been identified, the first person said. The vast majority of those accounts were reviewed and fixed by the spring of 2016.

External consultants were also engaged to review corporate governance practices and the company's senior management team, leading to a number of changes to the top executive ranks. KPMG declined comment for this story, citing client confidentiality.

For years, parent Home Capital positioned itself as a growth company with residential mortgages comprising the bulk of its business. As its principal operating arm, Home Trust has a significant market share of so-called Alt-A residential first mortgages, which are geared to consumers, such as new immigrants or self-employed applicants, who don't qualify for conventional home loans from major banks.

Home Capital, however, is facing an uncertain future. The company, which is seeking new funding, has been drawing on an emergency loan from the Healthcare of Ontario Pension Plan as a result of the rapid withdrawal of customer deposits, which have impaired its ability to fund its mortgage business.

Preet Banerjee calculates how much land transfer taxes or fees could cost a home buyer across Canada
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