The most important company in Canada’s non-prime mortgage market today is Home Capital. Not because it’s the #1 lender by volume (that honour goes to Equitable Bank), but because its fate drives sentiment and liquidity in the non-prime space.
And that sentiment is on the upswing. Check out Home Capital’s stock price over the past 30 days. (If you’re short, check your watch. You’re probably running out of time to cover.)
After a disastrous near-fatal second quarter, the company is getting back on track. It’s now renewing more than three out of four existing borrowers, which is similar to its ratio before the company blew up last spring. It’s got sufficient deposits to fund new mortgages, and it still has another $2 billion available (worst case) on Berkshire Hathaway’s credit line.
Investors, brokers, credit-challenged borrowers and Home’s competitors all have one question now: What happens to Home Trust next?
And who better to answer than the man at the helm, CEO Yousry Bissada. Here’s his take from my interview yesterday…
Rob: Let’s start with some numbers. Q3 mortgage originations plunged a colossal 85%. Can Home Trust remain profitable at this new level of originations, or is your break-even point higher?
Yousry: First of all, you say, “half empty.” I say, “half full.” Sure we dropped 85% compared to third quarter of ’16, but we’re up about 300% compared to second quarter of ’17, when the company totally shut down. I’m not aware of any company, you may be, Rob, that has totally shut down and restarted its business, other than this one…We restarted in July. You understand the mortgage business and your readers understand the mortgage business very well. When you start midway in July, you’ve lost a lot of momentum for the quarter…You don’t get the first two weeks, for example, and then commitments come in and they’re 45 to 60 days out. So it’s not a full quarter and you don’t come in on a running start. You’re starting from stop in the middle of July. So when you consider that, we’re very pleased. We’re up 300% over what we did in the second quarter. In the second quarter, the only deals we did were [based on] the momentum from the first quarter. But we weren’t actually out underwriting.
Rob: So what can we expect going forward?
Yousry: To answer your [first] question now, we don’t think that’s our normal level of business by any means. We’re just back in the game and restarting. Our desire is to get back to being number one in this space, and we think we’ve got the assets, we think we’ve got the people, we think we’ve got the broker relationships, that that will happen. So we’re not satisfied with $385 [million] as a normal [originations] number by any means…If we stayed at $385 [million] for whatever reason for a very long time, as you saw, the company is profitable. We made $30 million after tax with only $385 million of originations. That’s because we have large assets, our assets on balance sheet…They earn us income every month. We have commercial mortgages, we have retail lending, we have credit cards, we have a whole suite of products that drive profitability in this company.
Rob: Since you answered that one so easily, let’s try some harder questions. Now, I’m not going to name him by name, but you let your EVP go, who was with the company 13 years and had really strong relationships with brokers…How come this guy was let go? He seemed so central to the business.
Yousry: I think, no one can ever really comment about why someone was let go. You know there’s confidentiality and the respect between the organization and the person who left. But, having said that, I’ve got to do what’s right for the company, considering a number of different things. It’s never one or two or three things, it’s a number of different things, and I came to the conclusion that we needed to make a change. And the guy I brought in…[Ed Karthaus] knows brokers extremely well, is a guy who has endless energy to work and make it successful, he has relationships with broker leaders and brokers themselves. So it’s not an unknown entity coming in leading it, it’s a very well-known entity…We want to deliver service that brokers deserve and demand and I’ve got to put together a team that I think will do that. Brokers deserve fast turnaround, brokers deserve fair answers, brokers deserve clear, transparent information on the deal they’ve submitted and on why we can or can’t do it.
Rob: Are there any supervisors or managers from underwriting or mortgage audit who are still employed at Home Trust today, that were there during the period when the fraud occurred?
Yousry: Yes, but those that were attached to the fraud are not here. That was a very, very, very small number of underwriters. The others had nothing to do with it and are very good employees and have always been good employees. So yes, the company has nobody here related to that tumultuous time.
Rob: Do you know where Home Capital or Home Trust ranked in terms of non-prime (Alt-A) volume in the broker space in Q3?
Yousry: I do not. It wasn’t first, I know that. But for sure we’re still in the top five.
[With respect to “non-prime” business]…somebody may consider that B business and C business. We don’t play in that at all. We’re Alt-A only.
Rob: And how do you define Alt-A?
Yousry: …Alt-A is high-deserving individuals with high-quality assets. They just don’t have credit history or they may not have other requirements that a bank needs, but they are well-deserving. They’ve got a high ability to pay back. Our arrears are among the lowest of banks in Canada.
Rob: So, for laypeople reading this, it’s safe to say your target customer these days doesn’t have the typical credit history or proof of income a bank requires?
Yousry: That’s right, but they’re ‘A’ credit with ‘A’ assets (i.e., the properties they’re mortgaging). We only lend in major urban centres, and we have to be always be very comfortable with the assets.
Rob: Shifting gears a bit…clearly you guys have looked into OSFI’s B-20 and thought about how it’s going to affect you in 2018. So as a rough ballpark, do you have a guess as to what percentage of uninsured borrowers the company closed in Q3, for example, that wouldn’t qualify anymore in 2018?
Yousry: You know, B-20 has a few components. The stress test and the co-lending are the two big ones. The stress test is the one that we think is going to have the higher impact to our addressable market, but we’re not still sure exactly how much it will affect our business because if an individual decides to borrow less, they might still qualify … Maybe they have other means to get gifted [down payments], or maybe they’re going to buy a less-expensive home or condo, etc., so that would qualify them. But offsetting that, we know we’re going to have better renewals, higher renewal rates, because some of our clients won’t qualify elsewhere, and that’s the same for the clients of several of our competitors. [These borrowers] won’t qualify, so we’ll all probably win by higher rates of renewals.
And what also makes it complex for us is our market, which is significantly immigrants and self-employed, those two segments are growing every year, so they are adding to our addressable market. Even though some of them won’t qualify in the future under B-20, there’s still a lot that will qualify from those two segments, and [both segments are] growing…
The other thing is, B-20 affects the A-lenders. So there might be some runoff to us because they won’t do [certain deals], but we will…So what we’ve officially said is we need a little bit of time to see what the impact of [B-20] will be to our business.
We’ve done some internal stress tests for sure to try to understand. But just sort of to repeat a point about this, if you find that you had a mortgage on your book that doesn’t qualify under the 200-basis-point stress test, what we don’t know is, if we had gone back to that particular client and said, “Can you come up with five thousand more dollars, or can you get a guarantor,”…could they have done it? The analysis isn’t that smart. It just says, “If you look at it and without any further information, here’s what could happen.” What we provided in the public markets is to say, “Look, let’s say it affects our volume by 10%…Let’s say it affects our company by 20%”…We gave ranges, and in the 10% scenario we stayed pretty flat in terms of our assets if we don’t do anything else; and in the 20% scenario we go down by about 6%. But…we may have means to get mortgages elsewhere, such as commercial mortgages, such as trickle down, such as more immigrants, all the things I just said.
Rob: Got it. So I was talking to another non-prime lender about Alt-A strategy and they’re looking into the possibility of lowering their contract rates, but increasing fees to borrowers in order to qualify more people under the new regime. Have you thought about that at all?
Yousry: You know, I’ve heard that and right off the mark, we don’t want to play games with what OSFI is trying to do. OSFI is very clear on why they’re designing these policies, and we don’t think it’s our place to try to figure out how to beat the rules. So you know, if the whole market went that way, what we’d do is call OSFI and say, “Here’s what’s going on. We need to be competitive,” but we wouldn’t just do it to try to circumvent the rules; we want to honour OSFI’s intention with these rules.
But you know, even if you lowered the rates, you’ve got to underwrite to the Bank of Canada five-year qualifying rate, which is close to 5.00%. So you’re not going to underwrite it less than five. And our average rate right now is around 3.90%, so we’d have to underwrite it at 5.90%, or 5% if we got cute. But it’s not going to bring it below that.
Rob: How much higher is Home Trust’s maximum allowable total debt service ratio compared to a typical bank?
Yousry: It would be slightly higher.
Rob: Okay, so what about increasing your maximum TDS? Could a non-prime lender simply decide in its residential mortgage underwriting procedures (RUMP) to raise its total debt ratio limits? Are non-prime debt ratio maximums restricted by OSFI?
Yousry: They’re more governed by good risk policy…We are a regulated institution so [the regulator] has access to our risk policies and our points of view … They don’t specifically say, “This is what you can or can’t do.” But they have access to it all and if they felt you were misbehaving they’d come in and have a chat and you’d have to explain why you felt you could take on that extra risk, and you’d have to satisfy them. If we ever did that, and there are no plans to do that, we would have to have all sorts of data to satisfy ourselves first that it’s a risk worth taking; and second, that if we were probed by the regulator, that we could explain it. But we don’t have any plans to do that.
Rob: Have you spoken to Home’s most illustrious investor, Warren Buffett yet?
Yousry: No…I’m sorry to disappoint, I have not yet talked to him….But I’ve talked to a fellow by the name of Ted Weschler. He is considered second [in command] within the organization. He is very supportive, very good to talk to … I’ve never met him, it’s just been telephone conversations … Very supportive of Home, very supportive of the Canadian mortgage system, very supportive of regulators, very supportive of the new board, very supportive of new management. But it’s not just him … Our second-biggest investor is a company called Turtle Creek, whom I also have constant communication with, and they’re equally supportive of all of the above. It’s a good feeling when your owners are aligned with what you want the company to be.
Rob: Has Warren Buffet’s team at Berkshire had any role in the last quarter with Home’s operations? For example, will they call up and say, “What are you guys doing here? Have you thought about doing this or that?” Do they have any input in the operations?
Yousry: Not at all. They do not interfere at all. They don’t ask for a board seat, they don’t ask for any special financial information, they take what’s in the public domain and use that for whatever they need to do. They don’t interfere whatsoever.
Rob: Moving on to more practical matters of concern to mortgage brokers, way back earlier this year, Home stopped offering certain incentives to brokers. Is there any visibility on when those incentives might come back?
Yousry: We have a loyalty program…called “Spire”…We are renaming it and re-designing it…That will come back … that may not be immediately, but Ed’s looking at bringing it back to the market. We want to be as competitive as our competitors are with brokers…
Rob: Okay. One little factoid from the conference call that was interesting was that Home is reportedly declining over 70% of applications it receives, which is obviously much higher than in the past. So, if you’re a broker and you see that, how do you guys convince that broker to send you stuff with seven out of 10 getting shot down?
Yousry: So, you’re right. It is a little over 70%. We have a couple of strategies for that. As Ed is getting his team together, one of the priorities is going to be to go out and educate, so we make it clear what is the type of business we accept. We haven’t been in the market for a while, so we think people are sending us whatever, not knowing what our new risk and policy guidelines might be. And they’re not much different than the past, there’s just a bit more on due diligence…
The second part of that is we think we’ve probably declined stuff we shouldn’t have. As we start using the new systems, as we are training new employees, we think we’ve taken more of a hard line point of view than we needed to. So there’s some opportunity to improve our way of looking at deals, and that’s happening as we speak.
In my analyst call, I mentioned that we are getting measurable improvement every single week in our service, in our turnarounds, in our ability to say, “Yes.” So it’s those two things…[that are] resulting in way too much business being rejected.
Rob: How do the decline ratios today compare historically?
Yousry: Even in the hayest of days, we probably had a 25% to 40% rejection ratio…We obviously got a lot more applications than we’re getting today, and we approved a lot more on a percentage basis, but we never approved everything.
Rob: So you approved the majority of deals back in the day?
Yousry: Yes. And I think that would be normal across other lenders, Alt-A or otherwise; 25 to 40% would be normal. If you’re an Alt-A lender trying to deal in crème de la crème business, you’re rejecting more. But if you are more creative, it’d be 25 to 40%.
Rob: Makes sense. So by rejecting more, that means the underwriting criteria are stricter today than they were a year ago?
Yousry: It’s not stricter, it’s maybe more due diligence…[There is] not a clear message of what Home is looking for to the market, so the market doesn’t know and throws whatever our way. And the second part is, we are undergoing major training on systems and people to make sure they are looking at deals in ways that are still acceptable to us. After going through what the company went through, for a lot of underwriters it’s just easier to say “no.”
Rob: What’s one example of a major underwriting reason why deals would get shot down today, whereas a year ago they might not have been? For instance, is it the quality of the property, the location? What types of underwriting limits are keeping so many deals from being approved?
Yousry: None. We’ve just got to improve the way we’re looking at [applications]…Remember, the majority of home deals are very clean. We got into issues a couple of years ago, but the majority of home deals are clean. What may be more onerous is the documentation [review] and certain other proofs. But we haven’t materially changed how we look at a deal.
Rob: So with respect to the majority of deals being “very clean,” what does “very clean” mean?
Yousry: Very clean refers to our underwriting guidelines and risk and governance controls. We have definitions of what “fits” for us. A very clean deal meets the definition, has all the documents included (so there’s less “subject to”), that the application is fully submitted with all information—a deal that anyone would say yes to, assuming it meets all the criteria. But I’m not saying that that’s why we’re having a high rejection rate. I think we’re having a high rejection rate because brokers are throwing anything against Home without having certainty of what we do or don’t do, and secondly, we are saying no to more than we should. We will fix that…
Rob: When brokers “throw deals” at you, I imagine these are mostly brokers that have dealt with you before and have sent you similar deals as before. But now those same deals being rejected? It appears the criteria today is more “conservative,” let’s call it, than the criteria one year ago. Is that right?
Yousry: No…Our criteria is very similar to the pas. It hasn’t changed. We may have more rigorous ways of making sure that a deal fits our bill, but if you look at what kind of deals we accept and don’t accept, it’s the same. It’s greater Toronto area, it’s 65% to value, it’s XY TDS, XY GDS, nothing like that has changed.
Rob: There’s a lot of residual concern about fraud, both in the mortgage industry in general and at Home because of what happened. And one of the things that was talked about on the conference call is that you guys use the Citadel system from Equifax to help identify fraud. I love publicizing such systems because it shows the tiny number of bad-apple brokers out there that they shouldn’t take shortcuts, that there’s actually technology being used to stop them. So, very briefly, how does Citadel help you identify fraud?
Yousry: So it’s a central database where any lending institution can report cases where there is fraud, or a perception that there may have been fraud, to at least alert us. We’ve been using it for almost three years. We use it exhaustively now. When we feel there are incidents like that, we will update it, but otherwise we use it to help us make decisions, because obviously fraud is an issue no financial institution wants any part of.
Rob: Thanks for the time today, Yousry, anything else you want to add?
Yousry: We are very appreciative of the patience of brokers and are very appreciative of the comments that they have made to myself and the sales team, including Ed, that they very much support Home and want to bring us a lot of business back. And we’re counting on that. We will ask for them to do that when we feel we’re serving them in the way they deserve.