Rumours about the severity of fraud at Canada’s biggest non-prime lender appear to be overblown. Based on Home Trust’s assurances on yesterday’s conference call, this past month may go down as a lesson for the industry, but it won’t go down as a harbinger of systemic risk.
The call revealed some interesting nuggets about how the mortgage industry operates. Here were some notable takeaways:
In a Nutshell
The company says the fraud it uncovered in broker files centred on “falsification of income verification documents.”
“The deficiency was that some of these (job) letters had been altered,” said Home Capital Group CEO Gerald Soloway. “…Instead of making $64,000 the person suddenly made $84,000.”
The fraud was revealed by an anonymous letter sent to a member of Home Capital’s board.
“We did inform the insurers and OSFI very early on,” said Home Trust President Martin Reid. Most of the questionable mortgages were insured and they will retain their insured coverage (unless it’s later determined that the company was responsible for the fraud).
The Extent of It
The 45 brokers Home terminated had been submitting questionable deals over a timeframe that ranged from a few weeks to several months, depending on the broker.
The bulk of the problem files were submitted in 2014, but some were submitted prior to 2014.
Of the $960 million worth of mortgages these brokers did last year, “the vast majority were on the level,” said Soloway. Only “a very small portion” of the deals were questionable.
Most of the terminated brokers had submitted more than one deal with falsified documentation. “Some of it could have been caught by the broker,” says Pino Decina, EVP Residential Mortgage Lending at Home Trust.
Reid said there is “no proof that the mortgage brokers themselves are responsible for this but the business flows through them so we hold them accountable.”
“In 26 years, it’s not the first time we’ve delisted a broker,” adds Decina. “Unfortunately it does happen, but nonetheless these cases are not representative of the broker community as a whole…”
On the conference call Soloway admitted: “Maybe we discontinued relationships with a few more than we should…Maybe a year or two out we’ll look at onboarding (some of) them.”
It Wasn’t an Inside Job
In our interview, we carefully clarified one key point with Decina. He says there were no instances found where a Home Trust employee was aware of fraud, but subsequently allowed the mortgage to close. That had been a widely circulated rumour for weeks now.
A “small number” of employees were terminated following this incident. Decina notes simply that they “could have done a better job” during the underwriting process.
On the conference call, an RBC analyst asked what many were thinking—that is, whether OSFI had given the company a clean bill of health. That prompted the most animated response of the day as Home’s CEO vehemently replied, “We as a company don’t talk about OSFI and what they’ve done…Ask your chairman of the Royal Bank if he’d like to comment on his OSFI relationships the next time they have a quarterly call…”
When we approached the banking and trust regulator, it told CMT: “OSFI is prevented by legislation from discussing the results of its supervisory work publicly.”
Apparently banks and trustcos are too, although it seems silly to outside observers that a company cannot make factual disclosures about OSFI investigations in public.
Either way, it’s a safe bet that OSFI has left no stone unturned on this issue. Home capital is a heavily regulated entity.
Reporting Broker Wrongdoing
“Some of the [suspended] brokers are still in business,” said Soloway, which astonished many observers on the call. The main reason: those brokers haven’t been found guilty of anything by the authorities.
OSFI says, “There are a number of different activities that can be considered fraud, and depending on the nature of the activity, a financial institution may have a duty to disclose the offense to the appropriate agency (e.g., RCMP, FINTRAC, Provincial Regulatory Authority).”
Home Trust did not report the brokers to the police. “We didn’t see any clear evidence (of wrongdoing on the brokers’ part) to report to the authorities,” Decina notes.
“The regulators and insurers are aware of who we had issues with,” noted Soloway.
“We took a hard-line approach” even if a broker had only one instance of falsified documentation, said Decina.
Interfinance Mortgage Corporation was reportedly one firm that Home cut off, according to this National Post story. We asked Ontario’s mortgage regulator (FSCO) if it could confirm this. It said, “To maintain the integrity of all of our investigations, we can neither confirm nor deny the existence of any specific complaints or investigations against individuals or businesses.”
Home could not report any brokers to REDX, a private industry repository of alleged fraud, because the company doesn’t subscribe to the system.
All this said, if FSCO does investigate these brokers (and why shouldn’t it?) and it does find wrongdoing, the agency could then take enforcement action.
It’s a sad reality in our business that fraud allegations are not more aggressively reported and investigated. Lack of resources, PR risk and legal liability are some of the reasons that we don’t see regulatory enforcement more often.
Industry on Notice
Despite the mortgage industry’s rigorous underwriting overall, you can bet that at least a few lenders will be further tightening income review policies in the wake of this debacle. No one wants this kind of risk and media attention.
In turn, brokers who seem to knowingly submit “bad paper” may be dealt with more harshly than before, as they should be. Hopefully the few bad apples in our business realize that lenders and insurers share information on shady brokers regularly.
Fraud is Part of the Lending Landscape
Every lender sees fraudulent applications and documentation. They have since the beginning of lending. In fact, virtually all lenders allocate for fraud in their profitability models.
Equifax estimated industry-wide mortgage fraud at $600 million in 2012, which was roughly 30 basis points (0.3%) of the $200 billion in annual originations.
“All the insurers do annual and semi-annual reviews of our portfolio,” said Reid, as they do with all lenders. Insurers “expect a certain percentage (of files) will be offside.”
From a broker standpoint, if you’re in this business long enough you’re bound to have unscrupulous clients send you illegitimate documents. The fact that you unwittingly forwarded those documents to a lender does not make you a criminal.
A Contained Problem
CAAMP issued a statement Thursday, rightly noting that, “Any amount of fraud is too much.” But we have to be realistic and add some perspective. Home axed 45 brokers, out of a pool of ~18,000 brokers in Canada who originate $70 billion a year, says CAAMP. Industry arrears are just 28 basis points and, by far, the #1 factor causing arrears is unemployment/underemployment, not fraud.
Gary Mauris, who runs Dominion Lending Centres/MCC, the nation’s largest mortgage brokerage operation with 3,600 agents, 71,000 annual originations and $23 billion in volume, told CMT, “At DLC we’ve come across maybe half a dozen instances of fraud in almost 10 years in the business.”
Most fraud is obviously unreported, but the absolute amount in our business is still measured in basis points, not percentage points. And believe you me, fraud occurs in bank and credit union branches as well.
“All of the insurers have conducted audits,” Soloway said. “…They’ve all indicated that our arrears and underwriting procedures are solid.”
Interestingly, from an arrears standpoint, the fraudulently obtained mortgages have actually been performing better than Home’s portfolio overall, said the company. That may just be chance.
Given this reality, Home Capital’s clarifications and short covering, it wasn’t surprising to see the market bid up Home’s stock 13% yesterday.
As for the mortgages that were improperly obtained, “We’ll look at them on a file-by-file basis” at renewal,” says Reid.
Home “may require (more) income verification” from these clients.
The company is “proactively” contacting some of the borrowers and updating their documentation.
Early Disclosure Helps
This debacle may make a good case study someday on how not to manage disclosure of damaging news.
Given all the harmful rumours flying around and the destruction of shareholder equity, many believe the company’s disclosure about the extent of the fraud was too long overdue. Had people known that it was “only” 45 brokers and no employees or appraisers were involved, the damage could have been mitigated. This proves that a little information is dangerous, with the market drawing conclusions prematurely based on a lack of detail.
The company cited quiet period regulations as part of the reason it waited until earnings to discuss the extent of the fraud. Yet it nonetheless made other comments about the incident during that period (which ran between the end of the second quarter and the release of Home’s quarterly earnings announcement).
Next Steps for Home
The company will absolutely recover from this incident but it won’t be a cakewalk. The terminated brokers accounted for 7% of non-prime and 32% of prime originations in 2014. That’s a truckload of volume to make up.
As a result, we wouldn’t be shocked to see Home sharpen its pencil on rates, run more promotions, improve broker compensation and/or add other broker perks to generate volume gains. The company also said it would broaden the number of brokers it does business with, redo its broker portal and add a new broker loyalty program later this year.
Home has now separated its sales and underwriting functions, and strengthened its income verification procedures. Those procedures include running income docs through a specialized team. Previously, “we didn’t phone to verify the income,” says Soloway. “…We now…won’t do an insured loan that requires proof of income…(without verifying income and employment).” On a side note, Home has not been the only lender to not phone employers.
The company will now try to put this nightmare behind it and get back to business, but the street will undoubtedly be watching for any reoccurrence of these events.
As our interview concluded, Decina had this to say: “Despite all the online comments and unfounded speculation about Home Trust’s future, we are grateful for the continued support of the many brokers we work with each day. Home Trust has been a dedicated participant in the broker channel for over twenty-five years and remains committed to…our broker partners.”