Home Capital’s woes are not the start of a banking crisis

In case you’ve missed the Canadian business story of 2017, here is a snapshot of what it is – the stunning collapse in the share price of mortgage lender Home Capital Group, and now the ill-informed commentary from some who think there is a chance of “contagion,” that is a run on deposits at mortgage lenders such as Home Capital and the big banks that would cause a systemic crisis in Canada.

Let’s start with the basic facts.

Home Capital Group has been around for three decades and is Toronto-based. It makes its money by borrowing cash (mostly through deposits) by paying rates higher than what banks pay for deposits and loaning that money out at a higher rate of interest than what banks charge – loans that are mostly in the form of consumer mortgages.

It serves what is deemed by some as the “alternative mortgage” consumer, that is the self-employed, first time buyers and folks who have at one time declared bankruptcy. In other words, debtors banks generally avoid because statistically they have a higher delinquency rate.

Home Capital found itself in some trouble a few years back when it was revealed that some of the mortgage brokers it was using to source customers overstated the income of those consumers or failed to verify income. Home Capital should have been more careful and it soon identified the brokers and stopped using them. But this situation has been a source of ongoing issues for the mortgage lender.

On April 19, the Ontario securities regulator created a storm of concern when it publicly accused Home’s leaders of not accurately conveying to investors how it dealt with the mortgage brokers that had in the past sourced consumer mortgages with dodgy financials.

That’s all it took for the firm’s share price to drop a whopping 65% the next day and for many depositors to start draining the bank of funds for fear that the mortgage loans provided by Home Capital may be in jeopardy.

And that drain on deposits led Home Capital to seek a $2-billion line of credit to shore up its liquidity so that it could manage the outflow of funds and explore ways of fixing this problem.

Banking in Canada is a boring business today, so a little drama like this one is stirring both media excitement and some fairly odd views.

Take for instance the view presented by Jim Hall over at Mawer Investment Management in Calgary. When asked by Bloomberg about Home Capital and the withdrawal of deposits, and the possibility that Canadians could start withdrawing deposits from their banks, Mr. Hall had this to say: “The probability has gone from infinitesimal to possible — unlikely, but possible … If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”

Such a comment at this stage of the game strikes one who knows about such things as, well, fake news.

Here is why.

There has not been one news report suggesting that Home Capital is facing a situation where it has handed out large numbers of bad loans that are not being repaid. Lending has not created the liquidity crisis. Some have pointed to the very high rate of interest Home Capital is paying on the line of credit, but again Home Capital was responding to an immediate challenge to the quality of its credit and needed cash asap – asap cash is the most expensive because the lenders can only do a cursory amount of due diligence before advancing the funds.

The liquidity crisis Home Capital faces is tied to the Ontario securities regulator raising doubts about how management at the firm handled a case a few years back with some wayward brokers.

The assets Home Capital owns appear to be good, and if that is the case Home Capital will be bought out by a rival at a deep discount or a large swath of its mortgages will be securitized and sold off, giving Home Capital the liquidity it needs to pay off whatever amount it is using on the expensive $2-billion line of credit it secured following the run on its deposits.

Importantly, when financial institutions find themselves in trouble, depositors in Canada don’t run to their nearest bank and haul out all their cash. They do the exact opposite. They go to one of the Big Five banks and stuff all their cash in them. That has pretty much been the pattern since the late nineteenth century in Canada.

Home Capital may or may not survive this debacle. But one thing is for sure. The Canadian banking system will.







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