It wasn’t too bad of a concept: A bank that distributes a host of proprietary financial products through retail centres owned by its mortgage broker partners. Unfortunately for the company—Canadian First Financial Group (CFF)—it couldn’t get profitable fast enough to deliver on that vision.

CFF has bled millions and millions of dollars since inception, burning through most of a reported $40-45+ million in capital and having lost over $5.5 million in its last reported quarter. It got to a point where it was essentially forced to sell off the centrepiece of its business model, CFF Bank.

The buyer, Home Capital, gets a turnkey bank at a bargain ~$15 million +/- adjustments, or a mere 0.7 times book value (better known banks trade at about 1.7x book, as a median). Furthermore, Home Capital gets that bank quickly, without having to wait months or quarters for OSFI to approve its own 2014 bank application. That gets more deposits in the door faster, deposits that are essential to funding its lending businesses.

“The big bonus will be the bank name,” says Gerald Soloway, Home Capital CEO. “Under a bank name we’ve found that it’s easier to raise deposits from the public than it is with a trust company.” Mind you, Home has done well for itself as it is, with $15 billion in deposits compared to CFF Bank’s assets of $235 million.

While many CFF investors will be hugely disappointed with the bank sale, some remain upbeat. Broker and CFF Centre owner Brian Matthey notes: “Home Trust now has access to an exclusive group of high-end professional producing brokerage houses who see the light in the direction in which this industry is headed: more of a full-service operation, instead of a one-trick pony…CFF gets access to balance sheet funding and a broader funding source for competitive mortgage products in the “A” space, without relying on building a deposit base over time and relying on limited funders.”

We approached CFF Founder Karl Straky for comment as well. He didn’t speak to the loss of the bank, which was previously the “core” of CFF’s vision, but instead noted, “Our partnership with Home Capital strengthens our ability to deliver…to our Canadian First Financial Centre owners and provides a stable foundation for CFF Bank to continue to grow…We will continue to seek out (financial product) manufacturing ownership opportunities in financial services where it makes strategic sense and adds value to our shareholders.”

Here are a few other nuggets of note:

• The deal will close this fall, pending approval by CFF shareholders, the Competition Bureau and the Minister of Finance. My guess is, unless the government wants to see a bank fail (which it doesn’t), it’ll approve this deal post haste. In fact, given CFF Bank’s seemingly dire cash flow situation, we wouldn’t be surprised if the federal banking regulator had some kind of role in pushing this deal along. The last thing OSFI wants is a bank collapse on its books, which Canada hasn’t witnessed since 1991.
• There is no liquidity event for CFF shareholders. This is simply an asset sale. According to unconfirmed sources, some brokers invested upwards of $250,000 to 500,000+ in CFF.
• The $15 million that Home is paying will go into the holding company and its hundreds of shareholders will presumably have a say in what to do with it—i.e., reinvest it in the company’s new white-label product strategy, pay it out as a dividend, etc.
• For now, Home Capital will continue to operate the bank under the brand CFF Bank.
• Home did not buy the 37 CFF Centres as they are independently owned, and Home had no intention of buying and managing the distribution channel.
• CFF shareholders will not get stock in Home Capital. It’s an all-cash deal.
• Upon approval, Home Capital is expected to withdraw its current bank licence application.
• As for CFF Bank’s unique EasyOne savings account and line of credit (a slick account by the way), Soloway says, “We will continue that product,” noting that, “What we are looking to do is add products to the CFF bank.” (Incidentally, he says a HELOC is “not on the table” at this time.)
• As for new products, Soloway says Home hopes to distribute more non-prime and commercial mortgages through CFF Centres, which Soloway says the company has “a limited relationship with at present time.”
• Based on its limited product offerings and ho-hum interest rates, it seems that CFF Bank could not extract advantageous terms from mortgage aggregators (investors who buy mortgages). With home loans being such a crucial component of its revenue, this was a glaring shortcoming.

The above story illustrates how tough it is for small retail banks to flourish in Canada. It’s a brutally competitive business that relies on scale and access to low-cost capital. Many lenders have grand ideas of getting a bank licence to sell GICs/deposits and diversify their funding. But, as this case study proves, Canadians aren’t falling over themselves to park their savings with unfamiliar financial brands.

“Getting a bank licence was clearly a mistake for CFF,” said one top lender executive who didn’t want to be named. “Unregulated entities have more MBS leverage than banks and they don’t have to spend a million or two a year on regulatory compliance.”

One of the others who voiced skepticism was Dominion Lending Centres President Gary Mauris. Almost two years ago, Mauris made what was— at the time— a highly controversial public statement on Facebook, but one that seems prescient today: “We believe they (CFF) are very uncertain about their model, have huge shareholder and institution debt and anyone invested will have significant challenges with an exit strategy.”

Going forward, events like this may intensify regulator’s scrutiny. “Not a lot of bank licences are given out and those who apply for a new licence will have a higher hurdle to prove a profitable business model,” Soloway says.

Regulators will certainly keep CFF Bank’s Achilles heel, a shortage of working capital, top of mind. Banking is a capital-intensive, regulatory-intensive and investor-intensive business. Growing a bank requires ever-increasing amounts of funding, and it’s tough not to dilute shareholders along the way.

But all is not lost for CFF. The bank is no longer a drag on earnings and there is value to its distribution network, which is comprised of high-calibre brokers. It’s now a question of how much it can earn with white-labelled loans, credit cards, GICs, etc. This is where we find out what its management is made of—that is, if shareholders buy into this plan B.