The big story of earnings season was Home Capital’s postponed earnings conference call last Thursday. Its purpose was to brief investors on the company’s efforts to shore up funding and market confidence following its liquidity crisis.
The interim management tried its best to reassure listeners, saying they’re hopeful the funding arrangements made to date will buy them enough time to regain financial stability.
“The situation that we are in…will have a long-term impact on the company,” said Bonita Then, interim CEO. The terms of the new funding arrangement and the $2-billion credit line will lead to a greater focus in the near term on originating mortgages to sell rather than keeping on their balance sheet, she added.
“We anticipate that this will result in lower overall mortgage balances, increased costs and reduced levels of profitability in the near term.”
The full conference call transcript is below, along with highlights from First National, Home Capital and Street Capital Bank’s earnings announcements. The comments in blue deserve particular attention. Our thoughts are in italics.
“We face 2 major issues. First is the need to restore confidence in the future of the business. Second is to secure additional funding to allow us to continue the business.”
“I want to assure those listening on the call and beyond, our shareholders, depositors, employees, customers and partners that we are working diligently to ensure that we return to being a strong company and continue to play an important role in the market.”
Bonita J. Then, Interim CEO, Interim President and Director:
The situation that we are in, though, will have a long-term impact on the company. The liquidity events we have faced have led to actual and potential negative effects on the business. The terms associated with our $2-billion credit line are going to have significant negative effects on our financial performance in 2017.
We have tightened our lending criteria and have been reducing some of our broker incentive programs and expect that will result in a decline in our originations and renewals. In addition, the terms of the new funding arrangement using sales replacement as well as the company’s $2-billion credit line will lead to a greater focus in the near term on originating mortgages to sell, rather than holding them on the balance sheet and funding through deposits, as Home has traditionally done. We anticipate that this will result in lower overall mortgage balances, increased costs and reduced levels of profitability in the near term.
“…we recognize there will need to be some restructuring within the company.”
Robert J. Blowes, Director, outlined steps taken to bring stability and liquidity to the company:
Home retained RBC Capital Markets and BMO Capital Markets to advise the team on financing and strategic options
It entered into an arrangement with a firm commitment for a $2-billion rescue line of credit provided by a facility led by HOOPP, the Healthcare of Ontario Pension Plan. The facility is secured against the portfolio of mortgages and matures on April 30, 2018, although it can be paid off earlier without penalty. As of last week, Home had drawn $1.4 billion against this facility
It entered into an arrangement with an independent third party that wishes to accept mortgage commitments and renewals up to $1.5 billion (the media report this company as being MCAP)
Home received $154 million of proceeds from the sale of its preferred shares portfolio
“While these steps addressed our immediate liquidity needs, there has also been a disruption of our normal business processes, including the flow of fixed-term deposits,” Blowes added. “We depend on a consistent flow of these deposits to support our lending activities. Consequently, there has been some disruptions in lending activities.”
“Given the cost of the $2-billion credit line, repayment of amounts drawn under this facility in a timely fashion is an essential part of management’s plans. This may necessitate asset dispositions, scaling back of volumes until our funding capabilities return to normal levels,” Blowes added.
Asked about the third-party arrangement and what happens to those mortgages when they come up for renewal, Blowes answered: “So the mortgages would leave our balance sheet and we would not expect to see those customers again under that arrangement, and they would be serviced by the new owner… the arrangement is finalized, but the takedowns will happen as we present the renewals or commitments for their assessment.”
Asked if a run-off scenario has been considered in the company’s planning, Alan Roy Hibben, Director, said, “a run-off scenario is only going to occur if every other option that we’re exploring doesn’t work. At the moment, I have quite a bit of confidence, given the number of people that have talked to us about the wide range of funding and other strategic transactions that a run off is very unlikely.”
On whether the company has experienced any difficulty raising GICs, Benjamin Katchen, EVP of Deposits & Consumer Lending, said: “The deposits continue to flow widely through all of (our) channels (although) the volumes are lower than we’ve had in the past…”
Asked about the magnitude of impact that could be expected on shareholders’ equity, Hibben replied, “other than the fact that we paid $100 million fee, that is obviously going to impact things, the rest of the profit that we’re having to give away to this third party because of the change in rates can be absorbed in earnings.” Rather than selling the loans at a discount, as many have assumed, Hibben noted, “It’s essentially a mark-to-market on interest rates.”
On asset erosion, Blowes said: “There hasn’t been any significant erosion of the asset book. It remains at historic levels. It’s very strong in terms of credit quality, it has been over the past few quarters. No significant changes there. And that’s one of the reasons we’ve been able to enter into arrangements to deal with our liquidity issue.” He added that the collateral on the credit facilities is a 2-to-1 collateralization. “As our book changes, the collateral pool will change to reflect the quality of underlying mortgages, so it could be a higher margin rate depending on that quality. But today, it’s on a 2-to-1 basis.”
Asked about how the company was able to recruit its new board members given the uncertainty of the situation, and whether a high level of compensation is involved, Hibben replied that the new members have worked together previously and have a “significant degree of comfort.” He added: “nobody cares about money here. Everybody is interested in trying to do the right thing systemically for Canada. And particularly, we were attracted to the fact that this company services a niche within the marketplace that nobody else is going to service. (Not true: Numerous lenders stand ready to service it. –cmt.) So if this company were to not succeed, it would have significant knock-on effects, particularly to new Canadians and others who this company services. So no, it’s not money.”
On the ability for the market to absorb Home’s portfolio in the event they can’t access sufficient funding, Hibben said: “I think the estimate the guys have here is that we’re about 10% of this marketplace and a lot of the marketplace is informal. In other words, not funded by regulated financial institutions, it’s funded by people and family offices and a range of other things. So we have some degree of comfort that if we can’t refinance people and if this arrangement that we have with a third party can’t refinance people, that there will be refinancing options. But there’s no question there is the risk of dislocation in this marketplacebecause of that.And what you’ve already seen is rates have gone up dramatically. Underwriting continues to tighten. But we do think that there are other outlets. But we’re putting a reasonable amount of refi into the marketplace all at one time.”
National Bank analyst Jaeme Gloyn questioned references to the size of Home Capital in the marketplace, saying, “(we’ve) heard estimates in the range of $30 billion to $50 billion for alternative mortgages, and you’re suggesting that your $12 billion is now only 10% of the marketplace…what’s driving that delta that would suggest the market is [$120 million] versus other players’ estimate of $30 billion to $50 billion?” Pino G. Decina, EVP of Residential Mortgage Lending, answered: “…the alternative market is very fragmented. You’ve got institutional lenders across the country. The majority of it is serviced through private lending. But we’ve tried to do over the years numerous analysis on really how big this market is. And I think you’ve heard us say this before. If the Canadian residential mortgage market stands at about $1.3 trillion, $1.4 trillion, there’s about 25% to 30% of the consumers that, in any given time, can fall out of that space and require alternative funding. So that would be the size of the alternative space as a whole. And then, institutionally, we would be some 5% of that number.”
Executives were asked about their profitability forecast and whether they expect to remain profitable through Q2 and Q3. Blowes replied, “It’s too early for us to calculate that because there’s other strategies we need to execute on. But I think, Q2, we’ll have to absorb a number of charges.”
Hibben noted that they are seeing new deposits, though at a lower level than in the past. “Over 90% of our deposits are…under the $100,000 limit for coverage from CDIC, and that remains quite an attractive investment for many depositors,” he said. Blowes added, however, that, “outflows are greater than what we’re taking in and that is consistent with the liquidity issue that we faced.”
Executives were asked, given the attractive stock price (currently at less than 3x earnings) and the fact that the company has repeatedly said there is no asset quality problem, whether there are interested buyers, such as another bank. Hibben said, “we have a number of people that are interested. And clearly, in a steady-state situation, this company is vastly undervalued. And yes, we do have a number of people who are interested in giving us financial support and/or making a strategic investment or acquisition in the company… I don’t want to say, though, that we’re rushing in order to take that because I think some of the steps that we’ve taken are going to provide a bit of a floor…(it’s) very difficult to buy something at $25 when it’s trading at $10. Your own stockholders aren’t that keen on it. If we do the things that we think we can do here, then first of all, I think the market is going to appreciate that. And secondly, it will widen the range of strategic alternatives we have. But yes, it’s cheap in normal circumstances. When crisis of confidence happens, obviously, all bets are off until it’s restored. Crisis of confidence evaporates very quickly and returns slowly.”
Street originated $1.22 billion of new mortgages in Q1, up from $1.19 billion last year.
Street renewed $304.1 billion worth of mortgages in the quarter, “well within our target range of 75% to 80%,” said Marissa Lauder, Chief Financial Officer.
The average Beacon score of its portfolio was 746.
Mortgages Under Administration rose to nearly $28 billion.
“Our goal is to maintain a strong number four share position in the broker channel during 2017,” said CEO Ed Gettings.
“In Q1 our serious arrears rate was 12 basis points compared to the average of the large Canadian banks in the market where we operate at 26 basis points,” Gettings noted, attributing the low rate to Street’s strict underwriting practices and multiple verification methods used for validating income, down payments and collateral.
Gettings added that when Street launches its new uninsured mortgage product later this month, “100% of the applications will have a full property appraisal and a 100% will go through the quality assurance review.” He added that the uninsured mortgages, of which they plan to originate between $150 million to $200 million this year, will remain on Street’s balance sheet rather than being sold to investors, and that they will be funded with fixed-term GICs that will be matched with the underlying mortgage loans. Street also said it expects to generate a net interest margin of 2% to 2.5% from these loans. (It’s not unthinkable that Home Capital’s woes force Street to post higher GIC rates to win wary investors’ confidence.)
Gettings addressed the issues currently facing Home Capital, and questions about the viability of other lenders in the market, including Street: “We are a prudent and quality lender in the prime mortgage space and we will carry the same discipline as we expand into the uninsured space later this quarter… Our bank has not been affected by the recent funding and liquidity challenges experienced by some of the other regulated FIs in the recent weeks.” He added: “With recent market disruption, we haven’t experienced any reductions in the availability of funding or demand from our funders for prime insured mortgage products.”
“The foundation of our business is the prime insured segment… Market forces including the recent changes to mortgage insurance rules, increase the competition for prime matured mortgages. This has led to some spread compression that lasted longer than we normally expect and into Q1 2017. We saw some normalization in the latter part of Q1, and we do expect this spread to normalize as the market adjusts to these new rules.” (We don’t, at least not compared to the “normal” of old.)
“As a result of the recent mortgage rule changes, there was a growing segment of prime mortgages that no longer qualify for mortgage insurance; we refer to these as prime uninsured mortgages. Through one of our liquidity providers, we had accessed funding for these loans; however, we’ve approached the tail end of that current allotment.” (Which explains the company’s horrendous uninsured rates of late.)
“We had believed that our allotment would be increased and that other funders would become available, but market conditions have evolved such that progress has slowed down on this front. We are actively pursuing additional funding for the specific product, and with our industry-leading credit quality are in a strong position to attract it.”
Gettings said Street is actively investigating the market for non-government sponsored residential mortgage backed securities or RMBS, but that due to uncertainty over funding availability for prime uninsured mortgages, “we’re taking a more conservative view of new prime origination volumes in 2017 and expect that in total, newer originations could be down between 20% and 30% from 2016.” (Hell of a job reinforcing the oligopoly, Department of Finance.)
Marissa Lauder added: “we are beginning to observe some declines in commitments as our funding for the prime uninsured product is limited and our prices are higher than the market.”
Concerning the opportunity for growth presented by Home Capital’s current crisis, Gettings said this: “The events in recent weeks are likely to present substantial growth opportunities in the coming year. Our management team and Board will carefully evaluate these opportunities within our framework of prudent lending and growth. We have never thought to grow quickly at the expense of reputation of credit quality or by taking undue liquidity risks, and this holds true in the current context.”
Street reported less than 5% of its deposits in the 90-day cashable one-year GIC product. “Our deposit base on May 4th was $28.4 million, the term mix consists of 36% of one-year GICs, 13% to two-year GICs, 4% of three GICs… 4% of four-year GICs and 21% of five-year GICs.”
Following a review of Street’s current liquidity situation, under both normal and stress conditions, Lauder said “we determine that we do not need additional liquidity, either through our current warehouse lines or as a back-stop liquidity arrangement. We remain confident that our plan to originate $150 million to $200 million in uninsured mortgages this year is achievable within a prudent liquidity tolerance. We also remain on track to launch credit card operations in 2018.”
Notables from its call:
Mortgages under Administration in Q1 increased 5% year-over-year to $99.4 billion. Renewals were up 26% and new originations were flat from a year ago.
Single-family originations were down 3% from a year ago. The biggest drop in volumes was seen in Western Canada (down 12%) and Quebec (down 6%), offset by a 9% growth in volume in Ontario and the Maritimes.
“Entering 2017, we had expected to see a decline in single-family originations with some offsetting growth in total renewals and in commercial originations,” CEO Stephen Smith said during the conference call. “In the West, we believe the decline is a confluence of factors including Vancouver’s foreign buyer tax and the ongoing weakness in the Alberta oil patch communities. Our sense is that the recent tightening of mortgage insurance rules has also had an impact in these and other regional markets, although one was hard-pressed to see that here in Ontario in the first quarter.”
Smith noted that Toronto is an exceptional case and may remain that way, but added, “Even so, Toronto’s performance does nothing to change our general outlook, which is for lower single-family originations this year and heightened competition across Canada for a mortgage market that is being affected by government interventions.”
“Our basic thesis for 2017 is that recent changes to mortgage insurance rules will shrink the overall size of the insured single-family mortgage market and create greater competition for the business that remains,” said Executive Vice President Moray Tawse. “…the first quarter represented a period of transition for the new rules. Commitments made before the rules changed had funding dates in 2017. It’s difficult to determine what portion of first-quarter 2017 volume was underwritten under the old rules and what was produced in the new regime. In the second quarter, I think we will see the full impact of the new rules on insured single-family mortgages.”
Concerning the government’s latest rule changes introduced last fall, Tawse said this: “our belief is that when all is said and done, the rules introduced last fall will have a relatively modest impact on the overall Canadian mortgage market (Relatively modest if you’re a millionaire who can shake off 15 bps in higher interest costs. –cmt.); however the rules will definitely favour lenders who can most efficiently fund conventional mortgages. As a securitizer, First National has always originated insured mortgages for the CMB program and NHA MBS. As this market shrinks as a consequence of the new mortgage insurance rules, our seasonal volumes could be down significantly from 2016 results.” (That doesn’t sound relatively modest, does it?)
“…it is tough to forecast what will happen with single-family originations this year, although in the near term volumes will be down as the high ratio insured market shrinks and the competition in a smaller market puts pressure on the cost of broker fees,” Tawse said. But he noted several strategies First National has implemented to offset the declines, including capitalizing on renewal opportunities “by providing good customer service and competitive interest rates” (They didn’t do this before??) and by growing its commercial segment business.
Note: Transcripts are provided as-is from the companies and/or third-party sources, and their accuracy cannot be 100% assured.
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