Canada’s largest broker channel players have now reported fourth-quarter earnings. The quarter was unusually rich in earnings commentary, particularly about Ottawa’s latest mortgage regulations.
Most companies have downplayed the impact of those rules. But as all of us in the industry know, they could prove devastating over time to smaller mortgage players, players who nonetheless originate top-quality loans.
Below you’ll find the meat from the conference call transcripts of First National, Home Capital, Street Capital Bank and Genworth Canada. The comments in bluedeserve particular attention.
Street finally received approval for its Schedule I bank application. Street Capital Bank Canada officially began operating on February 1.
Street’s mortgages under administration shot up 12% to $27.7 billion year-over-year.
CEO Ed Gettings said one of Street’s objectives for 2017 is the launch of its uninsured mortgage product, with the first loan expected to be made this spring.
Chief Financial Officer Marissa Lauder gave this forecast for the new product: “We expect to originate $150 million to $200 million of uninsured mortgages in 2017, rising to $600 million to $700 million in 2018 and to $850 million to $950 million in 2019. This product is expected to earn a net interest margin in the range of 2% to 2.5%, and that includes the conservative provision for credit losses.”
Gross gains before acquisition cost, as a percentage of mortgages sold, was 166 bps in the quarter, compared to 167 bps in Q4 2015 and down from 184 bps in Q3 2016. Lauder said most of the decline in the ratio from Q3 2016 reflects the narrowing of spreads between mortgage rates and MBS and CMB rates in Q4.
“There is some uncertainty about the level of prime insured mortgage origination volumes that we expect in 2017, given the mortgage insurance rule changes,” Lauder said. “Right now, we continue to believe that a decline of up to 10% compared to 2016 is possible. We expect the softness, any softness, in new prime insured activities will be offset by a growing level of renewals, and the introduction of our uninsured lending product, which could potentially capture some of the previously insurable product.”
Gettings added: “…we’ve absolutely seen a significant drop in refis currently. However, it’s been made up in other areas such that our total originations are slightly ahead from last quarter.”
Addressing the mortgage insurance rule changes, President Lazaro DaRocha said that while January and February are seasonally weaker, Street’s volumes have so far been consistent with 2016. “It is difficult to predict with any certainty the ultimate effect of these recent changes. As we have some liquidity options that will mute the impact of reduced insurance availability…we continue to expect the insurance rule changes to have a relatively modest impact on 2017 originations of up to 10% decline compared to 2016.”
“As we have been saying for some time, Street Capital’s strategic imperative is not to materially increase its market share of insured mortgages in the broker channel,” DaRocha said. “We will seek to maintain our number three or four position in that channel, while focusing our energy and capital on building our banking platform and in the coming year, expanding into a full-suite retail lending financial institution.” Gettings clarified later that given the reclassification of MCAP and RMG as now being combined in the D+H lendermarket share reports, that Street “will alter our target to maintain the number four position in the market share, in the broker channel.”
Asked whether Street implemented any promotions that would have contributed to the strong originations in the quarter, DaRocha replied, “We didn’t have anything out in the market that wasn’t just matching what was in the market, whether it was rate to the consumer or a commission to the broker. So, no we didn’t have anything — we weren’t buying market share if that’s where you’re getting at.”
“…what we’re seeing in the (mortgage) spreads right now is we saw a little bit of softness in January, but it has started to return to higher rates through February and the beginning of March,” said Lauder.
Asked about expectations for mortgage originations for Q1, DaRocha said, “I know absolutely Q1 for the market must be down over the prior year, given what I’ve spoken to with several other people. But it’s really hard to say. All I can say is our volumes are flat to slightly up through February and our anticipation is Q1 will be flat to slightly up.”
Home Capital (HC) reported net earnings of $247.4 million for the full year 2016, down 13.8% from 2015.
Total loans under administration grew to $26.4 billion at the end of 2016, a 5.5% increase over the end of 2015.
HC reported “lower average balances in our traditional single-family residential mortgages (and) lower average rates.”
Net non-performing loans as a percentage of gross loans ended the year at 0.30% compared to 0.28% at the end of 2015.
Total origination in the quarter rose 14.5% year-over-year to $2.43 billion. Total originations for the year were $9.2 billion. “This performance represents the good progress our residential teams have made on improving service levels for the mortgage brokers driving increased volumes,” said former CEO Martin Reid. (Home Capital Group announced March 28 that Reid was being dismissed effective immediately.) “We saw our response times for commitments improve, improved turnaround times on documentation process, and better service levels on approval and funding while keeping standards within our risk management framework. Our core traditional single-family residential line saw its volumes increase 3.5% to roughly $5 billion in 2016 versus 2015.”
Originations of insured single-family “Accelerator” mortgages for HCG’s securitization programs decreased 33% year-over-year to $347 million, impacted by the new insured mortgages rules introduced by the government. “…we expect Accelerator to be negatively impacted in 2017 as a result of these changes, however we anticipate a relatively limited impact on net income,” Reid noted.
“While there were many positive things happening across various business lines, our overall performance was negatively impacted by lower-than-anticipated retention and renewal levels,” Reid said. “This, combined with elevated expenses, resulted in lower net earnings. Efforts towards improving retention during 2016 were slower to take effect than anticipated… Over the last quarter, we completed a review of our strategies and we have refined our strategic plan to better manage costs, streamline our products, and drive revenue growth.”
Speaking to why he feels confident about Home Capital’s ability to deliver on its plans to grow profitability in 2017, Reid said: “Our first priority is to prudently strengthen our core traditional residential mortgage business… We’re looking at actively managing the full life-cycle of our customers while they have a mortgage with us and identifying all touch-points that offer an opportunity to promote retention. This includes looking at onboarding mortgage servicing in our contact centres to drive an enhanced overall customer experience. We work to improve our call centre’s handling of calls that signal the customer was likely to shift their business to another institution. Now we are working on productivity improvements through more streamlined process controls and digitization to be able to respond appropriately to customer requests in a timely fashion. Our second priority is to continue to provide innovative products and solutions to service all of our customers. As the regulatory landscape continues to evolve, we will remain innovative with new products to attract and retain customers.”
“We have launched a project called EXPO, an initiative that will target $15 million of cost reductions based on an annualized run rate of our Q4 2016 expenses excluding items of note savings over the course of 2017,” Reid added. “We expect this work to be complete by the end of 2017…. this will result in a restructuring provision to be taken in 2017 and more detail on that will follow in our Q1 results…There will be difficult decisions in the coming months, however, we are taking the necessary steps company-wide to strategically effect meaningful change.”
In addressing Home Capital’s challenge with customer retention, Reid said, “if you look at our customer base over the last five years, the credit quality of that customer is a lot better than what it used to be so they do have a lot more choices.” Pino Decina, Executive Vice President of Residential Mortgages, added, “it’s all about this new look customer that we’ve seen post B20. They have come on board with a higher credit quality, which also means that they have more choice and earlier on than clients that we’ve had in the past. So, it’s about developing new opportunities for our retention folks to better put their grips into these customers and make sure that they stay on longer term.”
Asked how they are going about competing for customer retention, Decina said, “you’re going to attack them earlier and the client is in a position where they’ve graduated from a credit quality standpoint, then certainly you’re going to have to be more aggressive on your pricing in order to extend out their terms.” Reid then said, “to add to that, these are clients that were already priced aggressively coming in the door so you had that margin compression as they were coming in the door. You may have to be aggressive in price in the renewal, but you also don’t have the same kind of origination cost that you would on new customers. So, you are saving a little bit on the brokerage commission.”
Asked whether there are plans for new products to support revenue growth, Reid spoke about the full rollout of Home Capital’s broker portal, Loft. “(It) will help to improve that service level of the brokers, which should in turn result in better originations,” Reid said. “We are looking at products in light of recent regulatory changes (and) how we can take advantage of opportunities that may exist in the market given the number of people that are impacted by that. There’s a number of other initiatives that we are looking at at early stages, but the ones that are going to have a material impact short term are going to be the service levels to the broker, those initiatives around that and around retention.”
Decina provided more details about the rollout of Loft ahead of the busy spring mortgage market: “…we’ve applied sort of that 80-20 rule to it. So by the time the spring market hits, 20% of our most impactful mortgage brokers will be on Loft. And the reason we’re in a position to do that is really as a result of the work that happened in the back half of last year…We continued the rollout to all the teams in our traditional group throughout the balance of 2016 and I’m happy to report that all the teams in Toronto are currently on that. And we’re in a position now to deliver confidently what we call our 688 service-level agreement. And effectively what that stands for is six-business-hour turn time on commitments on all approved applications, eight-business-hour decisioning on supporting documentation, and eight-business hours to instruct our solicitor partners. (CMT: This is a solid SLA compared to the average broker lender.) So those are the three key areas when speaking on mortgage originations and I’m happy to say that in the month of December although we did see a steady improvement leading up to the month of December, we saw all three meeting those service-level agreements.” Decina noted that those 20% of brokers who will be targeted first are the top producers who generate about 80% of Home Trust’s volume.
Responding to a question about Home Capital’s risk appetite in the Greater Toronto Area and falling LTV ratios on new uninsured originations, Decina said, “We’re just watching very closely in particular in the GTA on some of the big-ticket items, not being aggressive on loan to value where we don’t need to be. And when I say big ticket, we sort of look beyond that $1.5 million [price point] as sort of that step where you want to start to scale back that loan to value. And I think that’s prudent and probably an approach that we’re going to continue certainly throughout the year.”
Notables from its call:
Mortgages under Administration in Q4 increased 6% year-over-year to $99.3 billion.
Speaking about the year ahead, CEO Stephen Smith said, “This is likely to be a period of some upheaval in the housing markets, as government intervention aimed at reducing risk are likely to exert some downward pressure on activity and home prices.”
On the challenges that lay ahead for First National in 2017, Smith said this:
On the new stress test rule: “Our view is that this could slow insured market activity by 5 to 10%, which, while not overly significant, it will have a bearing on single-family origination opportunities and volumes this year.”
On the limit imposed on the insurability of conventional single-family mortgages, and refis: “We believe this rule change could significantly reduce the amount of conventional mortgages that are insurable and available for securitization in our NHA MBS and CMB programs. Although such mortgages can be underwritten on a conventional basis for our institutional funding partners, placement is generally not as profitable as securitization. As well, the introduction of these rules will almost certainly result in a reduction in the overall availability of insured mortgages, which would increase competition and result in tighter spreads, higher origination costs and compressed net securitization margins.” (CMT: In the “A” mortgage space, heightened competition will occur for high-ratio and previously insured mortgages only. By handicapping securitizing lenders, regulators have set back competition by almost 20 years on conventional mortgages.)
On the capital changes for mortgage default insurers: “OSFI has determined there are greater risks related to conventional loans between 65 and 80% loan to value and the result is that premiums for such insurance have recently increased by over 200%. The higher cost of insurance will have a direct impact on net interest margins on securitized mortgages for any conventional mortgage that the company elects to insure and securitize.” (CMT: To be clear, risk has not risen materially for mortgages with substantial equity—i.e., 20-35%. Instead, a group of policy-makers have unilaterally decided, without any conclusive evidence and contrary to their own internal stress tests, that they prefer bigger buffers in the almost inconceivable chance that masses of equity-rich homeowners default.)
“We will need to address these challenges through our strategies, but the key point is that our business model, the diversity of our mortgage markets and broad funding sources beyond NHA MBS and CMB securitization make us confident that we can respond effectively to change,” Smith said. “Just to be clear on the financial impact: most of the issues I’ve just touched on affect origination volumes. First National earns most of its profit from its $74-billion servicing portfolio and $26-billion portfolio of securitized mortgages. These portfolios will continue to provide earnings over the life of the mortgages.”
Commenting on Q4, Moray Tawse, Executive Vice President, said, “It wasn’t entirely clear sailing as our team in Calgary will tell you, but we managed to offset most of the impact of the 22% decline in new origination volumes in the Prairies with positive performance elsewhere. 2016 was also challenging due to increased competition from smaller lenders that were intent on buying market share.” (CMT: 4 out of 5 mortgagors, those being conventional borrowers, will no longer benefit from such competition.)
“Although First National is always competitive for our customers, we chose to win on service not on undisciplined pricing, and for the most part we were very successful,” said Tawse.
On regional challenges facing FN, Tawse noted that “in the last couple of months, real estate companies have reported slowing sales in British Columbia, perhaps associated with the foreign ownership tax. First National originates about 20% of its single-family mortgages from its Vancouver office so slowing housing sales there or other regional issues could have a negative impact in 2017.” Later in the call he added, “I think our Vancouver originations could easily be down 30% in terms of commitments.”
“In the face of potential challenges in the residential market for new mortgage originations, our plan is to seek some offset through our commercial segment business,” Tawse noted. “Commercial had an excellent year in 2016 with new originations up 9% to $4.8 billion, so we will look to keep growing there. There is also significant value in our single-family renewal opportunities and retaining those borrowers is a key focus for 2017.”
Responding to a question about what FN will do about refinanced mortgages that can no longer be insured or securitized, Smith said, “We securitized through NHA MBS and CMB approximately half of the mortgages, and approximately half our mortgages that are originated are insured. So what we would do going forward, we’ll reallocate our mortgages that are refinances that we can no longer securitize. We’ll put them either into our asset-backed commercial paper program or we’ll sell them to institutional investors.”
Genworth reported net operating income of $388 million in the fourth quarter, up 3% over the prior year. Net premiums written of $760 million were down 6% over the prior year.
“We expect the government’s mortgage rule changes to reduce the size of our transactional insurance market this year by approximately 15-25%, after accounting for changes in borrower behaviour,” said Stuart Levings, President and CEO. “This will, however, be partially offset by the recently announced premium rate increase. The increase will add approximately 40 basis points to our average premium rate for 2017 compared to the prior year.”
“Further changes are being considered by the federal government in the form of a potential risk-sharing arrangement, whereby lenders would share in a portion of mortgage default losses,” Levings added. “We are in the process of preparing a comprehensive written response to the government’s request for comment. As we have previously stated, we do not believe a risk-sharing structure would represent an improvement in the Canadian mortgage finance system, one of the most admired in the world today.”
“We continue to focus on regional risk dispersion and high-quality loans, driving down exposure to borrowers with low credit scores,” Levings said. “This increased our average credit score to a new high of 751 in 2016. In addition, home price appreciation in our statement remains more muted compared to the overall market, reflecting the reality of a constrained first-time buyer.”
“Based on our current market assumptions, we expect a full-year loss ratio range of 25-35% for 2017,” Levings added. “This range reflects our expectation of continued pressure from oil-exposed regions together with some normalization of losses in Ontario and B.C. in response to slowing housing markets.”
Speaking about the transactional premium rate increases that took effect on March 17, Levings said the increases averaged approximately 18-20%. “As a result, we expect that the average premium rate for the calendar year 2017 should be between 330 and 335 basis points, an approximate 14% increase over the 293-basis-point average in 2016. The price increases range from 11% at the 95% loan-to-value level to 127% at the 75% loan-to-value.”
Levings noted that Genworth’s current market share is around 30%. “We are cautious in this environment, as we should be, and we’re not going to be aggressively pursuing growth,” he said. “But…we definitely see an opportunity to invest in some of our processes around risk selection, and certainly look to grow that market share prudently a couple of points this year and a couple of points next year.”
Note: Transcripts are provided as-is from the companies and/or third-party sources, and their accuracy cannot be 100% assured.
By Steve Huebl & Robert McLister
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