Canada’s biggest non-bank lenders have all reported third-quarter earnings. In their earnings calls they outlined how they’re coping with Ottawa’s recent changes to the mortgage qualification and insurance rules.
Per usual, we’ve combed through their transcripts in order to see what they’re telling investors. Here’s a rundown of it all, with highlights inblue.
Street sold a record $2.85 billion in mortgages in Q3 2016 compared to $2.28 billion in the same period last year.
Gains as a percentage of mortgages sold were 184 bps in the quarter, above its traditional range of 178 to 182 bps.
“We expect the upward trend in renewal volumes to resume with renewal volume expected to exceed 2016 volumes by 30% to 35%, while 2018 renewal volumes are expected to increase by 35% to 40% over a very strong 2017,” said Marissa Lauder, Chief Financial Officer.
“…in Q3, our underwriting service returned to normalized levels following the underwriting adjustments we made in Q1 of this year,” said CEO Ed Gettings. “As a result, we generated strong performance during the quarter driven by higher new funded sales lines. We are looking forward to continued strength during Q4 as we target to remain number three or number four in the broker channel. During Q3, we retained our number three position in the channel, with a market share of 9.6%, up 1.2% from Q2.”
One of Street Capital’s objectives for 2016 “was to continue to generate renewable volume of 75% to 80% of loans eligible for renewal. Year-to-date, we have renewed $1.07 billion in mortgages, which is close to the 75% of those available for renewal,” said Gettings.
“The shifting regulatory environment further validates our long-term strategy to leverage our leading brand into a multi-product multi-channel opportunity,” Gettings added.
Street reported a tax loss carry forward balance of $325.9 million in the quarter. “This represents a real and sustainable advantage for the Company,” said Lauder. “We are currently not paying any cash taxes and will not pay cash taxes for many years to come. As a result, the net income after tax measure underestimates the true earnings available to the company.”
The serious arrears rate on Street’s mortgage portfolio was 11 bps in the quarter, “well below the CBA performance,” noted Lazaro DaRocha, President. That compares against 14 bps for the same period last year.
“In Q3, Street Capital came to an agreement in principle to sell mortgages to two more Canadian Schedule I banks,” said DaRocha. “We completed our first sales with one investor in October and we anticipate completing the first sale with the second investor before the end of the year.”
On Department of Finance Mortgage Changes…
“…the recent announcement of new mortgage insurance rules by the Department of Finance will have a modest impact on the business in 2017,” said CEO Ed Gettings. “We expect that this will be more than offset by higher renewal volumes and our transition to Schedule I banking platform.”
DaRocha: “…we anticipate 2017 adjusted net income to be between 4% and 7% higher than 2016 for the following reasons: The results of these [DoF] changes are expected to reduce new originations in 2017 by less than 10 percent. We have liquidity options that will mute the impact of reduced insurance availability. The modest reduction in new originations will be more than offset by strong growth in renewals.”
DaRocha added: “Utilizing our bank platform, we anticipate launching our uninsured mortgage product before the end of Q1 2017. That said, the risks of government-backed insurance availability continue to increase. Most recently, the Department of Finance issued a consultation paper on the concept of risk sharing. While the final structure that this will take is yet to be determined, we believe that some form of loan loss risk sharing will be implemented.”
“In our opinion, this will likely result in increasing costs of capital and, ultimately, rates for consumers. Obviously, this will add even greater pressure to mono-line unregulated mortgage lenders. However at the same time, there are some tailwinds on the horizon. Recently the Government of Canada announced a material increase in immigration targets from 2017…Immigration is a key driver of housing activity in Canada.”
DaRocha also noted that one of the reasons Street embarked on applying to become a Schedule I Bank was due to a strategic review conducted four years ago that found the mono-line unregulated lending business model faced limited growth prospects and increasing risks. “We saw not only risks to the availability of insurance, but also risks associated with the declining availability of government-sponsored securitization programs.”
“We are confident that the Bank platform will not only allow Street Capital to diversify its funding sources but, more importantly, allow it to raise its own funding for the expansion of products beyond an insured mortgage, thereby diversifying its revenue streams and allowing it to more dynamically address any future disruptions to market conditions be they regulatory or otherwise,” DaRocha said.
Asked about low-ratio mortgages that may not be eligible for insurance going forward, DaRocha replied: “…we do anticipate a drop in new insured originations next year. We believe there will be less than 10% from what we originated this year. We are comfortable that we have not only expanded our funders in terms of the numbers, but also in terms of the magnitude of volume they will take. We are in negotiations with a couple of them to get them to take more of the conventional low ratio, that’s always a continuing process for us…”
Home Capital had total originations of $2.54 billion in the quarter, compared with $2.5 billion, which takes total year-to-date originations to $6.8 billion from $5.9 billion in the first nine months of 2016, up 15% on a year-to-date basis.
Net non-performing loans as a percentage of gross loans remained low at 0.31% compared to 0.33% in the second quarter.
“…management is disappointed in the growth of revenue, net income and loan balances, which have come in lower than expected,” said Martin Reid, President and CEO. “Operationally, we have made changes in our business that have resulted in expenses increasing at a much faster rate than the growth in revenues. This combined with a more challenging and uncertain business environment, given the regulatory changes, adds greater uncertainty to the growth in revenues going forward. As a result, we will be revising our mid-term targets.”
Reid added: “…our future plans to reduce expenses will be over and above our other initiatives focused on revenues that are already in motion, such as improving service levels to mortgage brokers by reducing turnaround times on commitments and approvals, while maintaining strong risk management standards; getting more benefits from our broker loyalty program, Spire, and our broker portal, Loft, and driving initiatives to improve customer retention through improvements in renewal efforts as well as slowing down early redemptions.”
“The bottom line impact of [the Department of Finance] changes was not significant, particularly in light of the fact that insured mortgage lending is a smaller part of our business, as well as being a low-margin business,” said Reid. “We see the potential impact of these changes to be as much as a 60% drop in originations of our accelerator product. This would reduce after-tax net income by about $4.8 million, or $0.07 per share.”
On the changes to the low-ratio insurance program, Reid said this: “The two areas most affected are refinances and rental properties. This business will likely still qualify for a mortgage, but just not for an insured mortgage. They will likely shift from [a] lender’s insured portfolio to their uninsured portfolio. The potential opportunity for Home will be a function of pricing for that product. Although, in theory, pricing should increase, it is still unclear whether competitive pressures will keep pricing low or whether it will rise providing Home with an opportunity under one of our uninsured products, time will tell.”
Chief Financial Officer Robert Morten noted that Home Capital has now reviewed all of the customer files and income documentation related to mortgages referred by the 45 suspended brokers. “…there have not been any unusual credit issues on these mortgages. The value of outstanding mortgages originated by these brokers in the loans portfolio at quarter end was $1.14 billion, as compared to $1.3 billion at the end of the second quarter and $1.55 billion at the end of 2015.”
Asked about the progress of retention efforts of Home Capital’s traditional portfolio, Pino Decina, Executive Vice President, Residential Mortgage Lending, said: “…as we develop strategies to improve our retention of all of our customers, including our classic book or traditional mortgages, we are looking at the reasons why they are leaving across all fronts. So not just at maturity, where the largest focus obviously is always placed, but mid-term. So we’ve pretty much segmented the strategies into two groups for clients that are within 90 days of maturity and obviously those are renewal strategies, and then outside 90 days more of retention strategies, try to keep them on our books, graduating them on to a program if they are in that position, looking for other products to meet their needs and retain them with Home.”
Commenting on some of Home’s analysis in terms of consumer behaviour, Decina explained, “…traditional or classic mortgage customers usually take about 20 to 22 months to graduate. And when we say graduate, that’s going from an alternative A mortgage to an A-mortgage… Over the past couple of years, the traditional customer has come to us with a lot higher credit quality and the Beacon scores…These are real near-prime customers and so that life-cycle has really shortened. They are graduating at a much, much faster pace…(but) We know they’re going typically back to their bank of choice, which typically is what happens with our traditional customers.”
Asked about progress on efforts to reduce broker turnaround times, Decina provided this update: “We’re getting very close and have actually seen our successes in the past quarter, where our commitments are issued within six hours on approved applications. So we’re very pleased with that documentation review. We want to commit to within eight business hours, so one day, and then likewise with our solicitor partners.”
On the broker portal roll-out, Decina said, “we’ve actually just completed a full enhanced training for our staff here in Toronto. We are going to do the same for our branches and then start a more robust roll-out in Q1 of next year to our broker partners. We have made some enhancements to the portal, based on our pilot partners that were put on it. So we want to make sure our staff were up to date on those changes and again, full roll-out starting in Q1 next year.”
Notables from its call:
Mortgages under Administration increased another 6% year-over-year to a record $98.6 billion.
That makes First National Canada’s largest non-bank originator and underwriter of mortgages, and the country’s single largest commercial mortgage lender.
“The oil industry downturned and Western Canada continued to manifest itself with a 34% drop in single-family origination volumes out of our Calgary office,” said Stephen Smith, CEO of First National. “We’ve seen a contractionist market each quarter for over a year now. But this is the largest reduction in mortgage demand so far.”
“…we saw a decline in single-family originations of between 2% and 5% in other regions of the country in this past quarter,” Smith added. “We believe this is the result of some smaller originators choosing to buy market share with little regard to profitability.”
On the Department of Finance’s new mortgage rules announced on October 3, Smith said the most significant change for First National is the new mortgage insurance rules that increase the stress test for borrowers of five-year fixed high-ratio mortgages. “The stress test will have an industry-wide effect for all mortgage lenders, reducing volume of high-ratio mortgages by an estimated 5.8%,” Smith said.
Regarding the changes as a whole, Smith outlined the impacts on First National: “We believe these changes will have a disproportionate impact on non-bank lenders that use NHA MBS and CMB securitization as funding sources. First National has used portfolio insurance in the past several years to insure conventional mortgages, which were then securitized or sold to institutional investors.”
“What does this mean for First National? First, let’s talk about the impact on originations. First National originates approximately $22 billion of mortgages annually consisting of $13 billion of new single-family, $5 billion of single-family renewals and $4 billion of commercial multi-residential mortgages. Generally, about 50% of the new single-family volume is high-ratio insured, and about 50% of that amount would be affected by the new qualifying rate rules. For high-ratio originations for the nine months ended 30 September, 2016, our analysis would indicate that if we re-underwrote using the new qualifying rate, our origination volume would be reduced by 4.6%, or approximately $300 million on an annualized basis.”
“Accordingly, we anticipate a decline in high-ratio single-family mortgage originations going forward of approximately 5% to 8%, which works out to between $300 million and $500 million, or about 1% to 3% of total originations,” Smith said. “In context, this is a negative, but not a significant one. Of note, we do not anticipate any material impact on our other originations and renewals, as a result of these new rules and no impact on commercial lending at all.”
“Now let’s look at the impact upon profitability,” Smith continued. “First National earns most of its profit from $73 billion servicing portfolio and $25 billion portfolio securitized mortgages. These portfolios will continue to provide earnings over the life of the mortgages. Due to the economics of new single-family originations for First National, they provide little, if any, earnings in the year they are underwritten. Instead, profits are delivered to shareholders as the company receives service income, and the net interest margin from securitized mortgages. The fact that rule changes will have a negative impact on single-family originations in 2017 and likely in 2018 will have little to no impact on First National’s 2016 or 2017 earnings. Finally, let’s look at the impact on funding. While some conventional mortgages originated in the past would not now be eligible for any NHA MBS securitization, the company has institutional investors and asset-backed commercial paper conduits that can purchase such mortgages without portfolio insurance. In other words, First National has diversified funding sources and continues to participate fully in the market.
“Overall, we expect our scale range of single-family and commercial mortgage products, diversified funding sources and proven customer focus approach will allow us to continue to provide solid results going forward, in spite of these rule changes,” Smith said. “First National’s faced challenges in the past, economic, market oriented and legislative, and every time our business model has proven its worth. We expect this set of challenges to be no different.”
Looking forward, Moray Tawse, Executive Vice President, said, “We also expect the low interest rate environment to remain with us for the final quarter of 2016, such that mortgage affordability will remain at favourable levels. This provides a catalyst for continued market activity as does a relatively stable employment picture in most regions of the country and ongoing immigration levels, which are another driver of housing demand.”
Note: Transcripts are provided as-is from the companies and/or third-party source, and their accuracy cannot be 100% assured.
By Steve Huebl & Robert McLister
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