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Reverse Mortgage Showdown

HOMEQFrom an investment standpoint, few mortgage lenders present a better risk/reward than HomEquity Bank, a subsidiary of HOMEQ.

Its product, the CHIP reverse mortgage, has enormous upside in terms of growth, with extraordinarily low loss rates.

HOMEQ’s largest shareholder, Maxam Capital, agrees. It owns 14% of the company and sees “dramatic growth opportunities.”

So does Birch Hill, the company currently trying to acquire HOMEQ.

Despite both of them having a strong belief in HOMEQ’s future, they are not on the same page.

Maxam feels the company is worth far more than the $9.50 a share Birch Hill is offering. That’s led to a showdown between Maxam and HOMEQ management. (See FP’s story: HOMEQ deal faces opposition)

HOMEQ, which is backing Birch Hill’s offer, wants to sell now. “We definitely need to raise capital to grow,” President Steve Ranson told CMT.

Ironically, that’s not as easy as you’d think for a business with loads of upside.

Market Analyze“Based on where our stock was trading, we simply could not raise capital on a non-dilutive basis to our existing shareholders,” Ranson explained.

But Maxam Managing Partner Sean Morrison isn’t so convinced. “It’s not as difficult as they’re making it out to be,” he told CMT. “They haven’t tried going to (the public) market to ask for an equity offering.”

Ranson counters this, citing multiple hurdles to raising more equity capital, including but not limited to:

  • HOMEQ’s micro-cap status — its small market capitalization makes it “very hard” to get interest from large institutional investors, he says. “They tell us, we love the story but I can’t buy enough stock.”
  • Urgency — “The market and our investors were demanding growth and net income now, on a per share basis. But we can’t grow net income on a per share basis by issuing equity below book value,” which is what HOMEQ would have had to do, he says.
  • The market doesn’t get it — “In the second quarter of last year, we had our best quarter ever in terms of new originations, profit growth, spreads, you name it. We beat all our numbers….and the stock still went down by a dollar. It made us wonder, what do you have to do (to move the stock up)?”

CHIP-Reverse-MortgageDespite the above, Morrison argues it’s worth the wait to grow more slowly, using the company’s own means and existing financing options to achieve that. “There are very few opportunities to own monopoly,” he says. “In New Zealand and Australia, (reverse mortgage) penetration rates are very high.” CHIP’s growth spurt is in its infancy by comparison.

Morrison reasons that Birch Hill has a high cost of capital. It’s not paying $9.50 with an expectation of 20% gains. “Birch Hill is probably looking for a rate of return in the $20/share (area),” he says.

But Ranson maintains that Birch Hill is pledging more than just $9.50 a share. “They are giving up the dividend, essentially 28 cents a year. They’re going to retain that in the business…They are (also) committed to putting in more capital to help the business grow. So it’s not just a one-time transaction for them.”

For investors, it’s now a matter of:

  • A bird in the hand (i.e., a 21% premium to the price before the takeover announcement); or
  • Potentially two in the bush (i.e., a much higher potential takeout price if HOMEQ management can get creative and find another way to fund its growth).

Investors will vote and have their say at HOMEQ’s Annual and Special Meeting of Shareholders on May 28, 2012.

For Ranson’s part, he seems to believe that the opportunity is in cashing out now. He’s selling 60% of his stock (Birch Hill requires him to retain a stake so he has “skin in the game”). Says Ranson: “That’s a lot of stock to sell if I didn’t think the price was good.”

Reverse-MortgageTake II: Whatever happens, it’s likely that HOMEQ will be worth appreciably more in five years than it is today. Reverse mortgage demand is on the rise due to an aging demographic, low savings rates, and below-normal investment returns. Good or bad, this is one of the clearest trends in the mortgage industry.

It would be sad to see HOMEQ go private if, for no other reason, it means less public disclosure for analytic purposes.

On the other hand, Ranson says a capital boost would potentially allow it to invest in new product enhancements over the next five years, including:

  • A revolving line of credit option (enabling seniors to withdraw funds more inexpensively and in smaller amounts as needed, then repay those funds and re-borrow them if necessary)
  • Banking capability built into the reverse mortgage account
  • More convenient access to funds via debit cards and other electronic means

People who don’t like reverse mortgages will like them even less if it becomes easier to borrow from them. By contrast, seniors who feel CHIP is a vital option (and for some people, it is) will welcome this flexibility.

Robert McLister, CMT