Fourth-quarter earnings for the country’s largest broker channel lenders wrapped up a tumultuous year that delivered a mixed bag of results.
Just as Home Capital is recovering from its liquidity crises of early 2017, Street Capital now finds itself “middle of a multi-year transition,” according to CEO Duncan Hannay, as it adapts to the new lending environment created by a slew of regulatory changes.
The government’s October 2016 mortgage insurance rule changes impacted originations among all three lenders. Home’s single-family mortgage originations in 2017 were down 52% year-over year (though Q4 originations were up 126% from Q3). Meanwhile, Street’s prime mortgage originations in 2017 were down 32% from 2016, and First National saw a 10% decline (against a previous forecast of a 20% decline).
Highlights from the conference call transcripts from Street Capital, Home Capital and First National are below. The comments in blue deserve particular attention.
Home Capital reported net income of $30.6 million in Q4, up 2.1% from $30 million in Q3, but down 39.6% from $50.7 million in Q4 2016.
Total loans under administration stood at $22.5 billion, down from $23.2 billion in Q3 and $26.4 billion in Q4 2016.
Home’s “turn down” rate on mortgage applications improved to 60% from over 70% in Q3.
“It wasn’t just systems in Q3, it was kind of restarting up. Brokers aren’t sure what our guidelines are, so we’ve done a lot of education to brokers. We’ve done a lot of training internally,” said CEO Yousry Bissada. “We don’t know for sure what’s normal, but we think it’s going to be around 50%.”
Net interest margin stood at 2.02% in Q4, up from 1.85% in the previous quarter and down from 2.38% a year ago.
Single-family mortgage originations were $516 million in Q4, up from $201 million in Q3, but down from $1.326 billion in Q4 2016.
24% of Home’s residential mortgage portfolio is insured, with an average LTV of 55.3% for the uninsured portion.
“We are well-positioned to take back our place as the leading alternative-A lender in Canada by delivering solutions for our targeted Canadian clients,” said Bissada. “We will grow responsibly with sustainable risk management practices embedded in our day-to-day routine.”
He added, “On the commercial side, we added new staff that will be able to take on increasing volume as we continue to rebuild our pipeline. We are seeing good opportunities and quality deals. We are focusing on our priority of growing our residential and commercial business lines to more normal monthly run rates…On the underwriting side, we continue to improve efficiency through employee training and technology updates to our internal platforms and systems.”
Speaking about improvements to service levels, Ed Karthaus, Executive Vice President of Sales, said this: “…what we’re doing is all about people, process and technology. On the people side…we have ramped up staff both on the sales underwriting side of the house. From a process side, we’ve actually implemented a number of changes there to drive greater overall efficiencies. And on the technology side, making changes not only to our in-house systems, but the tools that our staff are using in order to engage the market properly and effectively.”
Regarding the new B-20 guidelines that came into effect January 1, Bissada said it is too early to quantify the effects. However, he noted that some clients have been impacted by the stress test and, as a result, qualified for smaller loans than they would have last year. “We will need more months of data to determine how borrowers have reacted to revised terms offered to them,” he said. “It will also take time to observe how much of our addressable market expands as a result of borrowers not qualifying at big banks…Early 2018 results suggest that our credit qualities of origination is improving, which will be an indication that some of the business previously booked at the Big Six banks is migrating to us for mortgage solutions.“
Asked about early renewal trends so far in 2018, post B-20 guidelines, Bissada said this: “Six weeks hasn’t given us experience. But in the fourth quarter, we were renewing at over 80%, so it’s getting healthy as before B-20 kicking in. First impressions into 2018 is we’re going to continue to be in that range, possibly more.”
Asked about the broker compensation that was suspended during the liquidity crisis days and what the plan is going forward, Karthaus replied, “we’re doing our across-Canada outreach to collect information, feedback from the broker community on what we believe would be a well-received program. We’re getting ready to finalize that and launch that in, sometime later on in Q1. And we believe it will address both our requirements as a provider of mortgage solutions, but also deal with the regionality that’s seen across the country with the different demographics in different markets.”
Street originated $5.4 billion in new prime mortgages in fiscal 2017, down 32% from 2016.
In Q4, Street originated $1.4 billion of new prime mortgages, down 46% from last year. However, it was noted that Q4 2016 was an above-average quarter due to borrowers rushing to purchase ahead of impending regulatory changes at that time.
Renewal rates stood at 75% in the quarter, slightly off from Street’s 75-80% ongoing target, due to “some higher-than-expected mid-term liquidations in late 2016 and into 2017.” In response to a question about the effect of B-20 guidelines that incentivize borrowers to stay with their existing lender, Chief Financial Officer Marissa Lauder did concede “…we could see some uplift in our renewal rates from borrowers having a more difficult time moving lenders, but we really haven’t included that in our targets at this point.”
Street originated $62 million in Street Solutions mortgages in the quarter at an average rate of 5.05%. “We are off to a good start in 2018, and remain very comfortable with the $600-700 million volume targeted for the year,” said Lauder. For 2020, Street introduced a target of $1-1.2 billion in Street Solutions originations.
Due to Street being “very selective about the product that we are originating,” CEO Duncan Hannay said they are seeing “very high” credit quality in the Street Solutions book.
Street’s new banking operations generated a deposit base of nearly $293 million, up from $198 million in the previous quarter. Interest rates on the deposits ranged from 80 bps to 3.09%, with Lauder noting, “we have been successful in passing on any higher funding we found in the funding costs in the market through higher mortgage rates.”
Hannay described Street Capital as being in the middle of a “multi-year transition from a monoline prime insured lending offering to a diversified modern, digitally enabled banking platform.”
He added: “…we anticipate further market-related volatility in 2018 based on what we have seen in Q1 so far, and we are not immune to these challenges.” And, “To the extent Street Capital is susceptible to these market vagaries, it is only because we are in the process of transitioning our model from markets where we have a dominant presence but are essentially a price-taker to markets where we can be a price-maker. The successful launch of our uninsured product last year demonstrates that we are on the right track.”
Lauder noted that Street is continuing to “proactively seek funding solutions for prime uninsurable mortgages, which is still a gap on our product shelf.” On prime uninsured funding, Hannay added this: “We’re still working through that, but we do believe that we will have a solution there within the first half certainly. And we do believe it’s going to be meaningful funding, although I think it still remains to be seen how the overall market responds in the category in 2018.”
On the effects of B-20, Lauder said, “It is still too early to judge the full impact of OSFI’s revised B-20 or other recent changes and developments in the housing markets. In terms of the recent changes to B-20, we still believe that there could be an overall decline in uninsured mortgage activity along with buyers adapting their borrowing habits to qualify, such as reducing their target price ranges.”
Regarding capital requirement changes for mortgage insurers, which caused premiums for low-ratio mortgages to rise, Hannay noted that it “…put us really at a competitive disadvantage versus a lot of the balance sheet lenders, particularly the big banks. And that’s created something of a regulatory windfall, I would call it, for the large banks and really put the small banks and monolines at a disadvantage in that category…with the new B-20 and so forth as the qualification criteria and the stress test kind of normalizes the market a little bit, I think that will begin to level the playing field again, and allow us to be more competitive.”
Asked if there will be any further restructuring within the company, Lauder replied, “…our best intention is we wouldn’t have any more restructuring charges into 2018. Having said that, the business evolves and the markets evolve, but it’s certainly not in our plans right now.”
Asked about Street’s planned new product offerings that would complement the mortgage portfolio, Hannay said: “one is a renewed, effectively, life insurance product, which would be credit or life that we’ll be rolling out as part of our overall mortgage offering. And the second one would be a home warranty solution as well, both of which we think can shore up and strengthen our overall mortgage proposition. And both of those new products are in the process of being rolled out as we speak.”
Mortgages under Administration in Q4 increased 7% year-over-year to a record $101 billion.
Single-family originations in Q4 were up 4% from a year ago and single-family renewals were unchanged.
First National’s commercial originations were up 21% year-over-year, with renewals up 16%.
Despite forecasting a 20% drop in single-family originations due to the government’s October 2016 mortgage insurance rules, which reduced the market and increased competition for insured mortgages, First National finished the year with a 10% decline below its 2016 numbers.
“We offset this decline by growing the other channels of our business,” said CEO Stephen Smith. “Single-family renewals were up 13%, commercial originations grew by 21% and commercial renewals increased by 16%. This was our commercial team’s most successful year on record.“
Smith attributed First National’s resilience in the face of challenging government policies to two things:
Diversification of its mortgage lending. “…while we’re known as Canada’s largest non-bank mortgage lender based on the size of our single-family book, First National is one of, if not the largest, Canadian commercial mortgage lenders.” (FN estimates its commercial mortgage market share to be under 15%.)
And the ability to “fully and quickly embrace the highest underwriting standards of Canada’s largest financial institutions, and then to efficiently and effectively comply by adjusting our revenue activities and capital allocations…”
Executive Vice President Moray Tawse noted that the number received some lift due to some borrowers accelerating their purchases ahead of the B-20 implementation on January 1, 2018.
“For 2018, we believe that B-20, along with the ongoing application of earlier policy interventions, will have a further damping effect on single-family origination volumes,” Tawse said. “There is a significant degree of uncertainty about the ultimate impact, but our sense is that the potential for strong economic growth, population expansion and supply-side constraints in many cities will provide offsets.”
Asked about the expected impact of B-20 on origination volumes for 2018, Smith said, “I think this time last year we were looking at changes that were an awful lot more challenging than this year. If anything, this year, these few stress tests don’t affect our insured book because that’s already happened in some ways…so we are only looking at the stress on the conventional portion.”
He added: “…even though there is a pressure on the stress test, we think it’s quite manageable. If I have to go…by our commitments for the first two months of this year compared to the last year, they are up (about 10%)…I think (in) January, the commitments were up…in excess of 20% and I think February is looking like it would further be up at more than about 50%.”
Asked what was driving such strong year-over-year growth, Smith said First National didn’t have very competitive rates early in the year in 2017, along with effects from the October 2016 mortgage rules and a variety of other factors.
Asked about how leveraged First National is currently, Smith replied, “I think generally here we look at ourselves as being under-leveraged. We have a lot of excess capital, both for regulatory reasons for our issuance program and just generally to support our assets, he said. “I think that’s one of the reasons that we had the special dividend last year, we thought we were quite overcapitalized…we make almost 40% a year on our capital so it’s a big cash generator (and) there is lots of excess capital.”
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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