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Greed and Capitalism
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Inside Canada’s Push to Contain the Fallout From Home Capital
by
Josh Wingrove
Finance minister pored over issue before calling big bank CEOs
Regulator steps up vigilance as analysts warn of contagion
As Home Capital Group Inc.’s shares were in freefall last week, the fight to stop the bleeding at the Canadian mortgage lender had already begun.
It
was late Tuesday night, Ottawa time, when federal Finance Minister Bill
Morneau received his first briefing from department officials just as
he was boarding a plane in Beijing to head home.
Bill Morneau
Photographer: Cole Burston/Bloomberg
Home Capital had been reeling for a week after the Ontario Securities Commission accused the company of misleading investors
over fraudulent mortgages. That was sparking a run on deposits, forcing
the company to take on a C$2 billion ($1.5 billion) emergency credit
line at an effective interest rate of 22.5 percent on funds drawn so
far.
Last Wednesday, with Morneau en route home, Home Capital’s
shares dropped 60 percent by lunchtime as investors bet the onerous
terms of the loan would squeeze the company. There was also contagion
risk. Canada’s major banks saw their shares slump, while Equitable Group Inc., a rival of Home Capital, plunged by almost a third.
Morneau
landed in Ottawa Wednesday night, calling his departmental officials as
he got off the plane for the latest information, according to people
familiar with the discussions. He later spoke with Jeremy Rudin, head of
Canada’s Office of the Superintendent of Financial Institutions, who is
responsible for regulating what the World Economic Forum has called the
“soundest” banking system.
On
Thursday, Morneau’s office pledged his support for Rudin’s OSFI and the
banking sector. “Our government has full confidence” in OSFI to “manage
the situation,” Morneau spokeswoman Annie Donolo said in an email.
The
pledge wasn’t enough to calm investors. While Home Capital’s stock
recovered on Thursday on speculation a buyer for the company might
emerge, the deposit run continued, totaling C$892 million over three
days to close the week. What’s more, the onerous terms of the high-interest lifeline, later revealed by Bloomberg News to be from Healthcare of Ontario Pension Plan, resonated beyond the company.
Run on Deposits
“We
looked and felt, what on earth are they doing?” Equitable Chief
Executive Officer Andrew Moor said in an interview. “We thought that
might cause issues of confidence in the market, frankly, and so
immediately we started reaching out to our bankers.”
Equitable started to face a rash of withdrawals too, losing
about C$75 million daily between Wednesday and Friday -- even though the
Canada Deposit Insurance Corporation provides a safety net by
guaranteeing deposits of up to C$100,000.
OSFI, meanwhile, put out
requests to lenders asking for updates to get a handle on the damage,
though spokeswoman Annik Faucher called it part of “ongoing supervisory
activities.” In a separate statement, she acknowledged the situation has
increased “our level of activity and vigilance.”
Canada’s
alternative lenders, such as Home Capital and Equitable, typically
offer mortgages to borrowers who have trouble getting home loans from
big banks because they lack a credit history, such as the self-employed,
new immigrants and small business owners.
Just as Moor was
reaching out to banks, Morneau was doing the same. On the weekend, he
spoke with heads of the biggest commercial lenders to discuss Home
Capital -- though precisely which bank executives he called isn’t clear.
While Morneau doesn’t consider Home Capital a systemic problem, he was
focused on assessing the risk its woes could spread to other alternative
lenders, according to people familiar with the talks. A core Morneau
message over the past week has been to ensure market stability.
‘System is Working’
By Sunday night, the commercial banks -- including Toronto-Dominion Bank and Bank of Nova Scotia -- agreed to a C$2 billion loan for Equitable at a rate of about 1.6 percent to 1.7 percent.
“Not
many people can go around and borrow C$2 billion off Bay Street in five
days,” said Moor, who said he received commitments from five of
Canada’s six big banks by Sunday night, with the sixth now on side.
It was Monday that Morneau -- a veteran of Toronto’s financial sector -- issued his first public comments.
“Financial
stability and security are the backbone of a strong and resilient
economy,” he said in a statement. “What I’ve seen over the last few days
is proof the system is working as it should.”
The credit line ring-fenced Equitable, which soared by a third on Monday morning, though bank shares continued to slide.
Next Steps
The question now is what to do next with Home
Capital. While it only accounts for 1 percent of Canada’s C$1.4 trillion
mortgage market, it still has almost C$18 billion in mortgages. If
withdrawals continue, it could be unable to renew them or bring in new
business. That could deprive potential home buyers of credit, adding to a
slowdown that’s already showing signs of developing in Toronto and Vancouver.
“This
could be just an isolated situation and that’s the higher-probability
outcome at this point, but you cannot ignore the risk that this can get
messy,” said Aubrey Basdeo, head of Canadian fixed income at BlackRock
Inc. “The focus now is on the potential for a systemic issue across the
economy and it would be folly just to ignore that.”
OSFI
has a four-stage intervention process -- stage four being non-viability
or imminent insolvency. That scenario could include OSFI assuming
temporary control of the institution’s assets, as well as it or CDIC
seeking government approval for a wind-up order. It’s not clear what, if
any, stage Home Capital is at. OSFI and the company declined to
comment.
In some cases, if a company is considered solvent but
illiquid, the Bank of Canada can provide a loan if the affected firm
provides plans for recovery. A spokesman for the central bank declined
to comment.
Home Capital has hired investment bankers for a possible sale, though buyers are scarce --
banks, pensions funds and private equity firms such as J.C. Flowers
& Co. and Fairfax Financial Holdings Ltd. have so far passed. A
piecemeal sale of the mortgage portfolio is another possibility.
Government’s Role
Morneau’s
job may not be done. Though the big banks would have passed on the
customers that took out mortgages with Home Capital, a co-ordinated pick
up of the loans is also an option. The company appointed Alan Hibben to
its board Friday, replacing the outgoing founder.
Some
in the financial industry argue government should take the lead. “It
certainly should be driven by Ottawa, for sure,” said Moor, Equitable’s
chief executive. “They have the resolution authority.”
Morneau has
stressed the importance of market-based solutions. After an effort that
stretched through the weekend, he downplayed any risk Home Capital
could trigger a market correction. “We do not see those two things as
linked,” he said Tuesday in parliament, adding the response so far “is
exactly the way the system should work.”
Direct government
intervention could encourage reckless behavior, Canadian Imperial Bank
of Commerce analyst Robert Sedran wrote in a note to clients. Likewise,
letting a lender fail “would create unnecessary instability in the
housing market, causing fear to mount and potentially spread over to the
banks.”
If current fears are any measure, efforts so far have
worked. Many analysts see Home Capital -- regardless of its ultimate
fate -- as an isolated issue.
“It’s not the beginning of the end,” said Benjamin Tal, deputy chief
economist at CIBC, noting the housing market is instead more vulnerable
to a recession or rising interest rates. “Home Capital is not the
ultimate test.”
Before it's here, it's on the Bloomberg Terminal.LEARN MORE
Billion Dollar Fund Manager Comes Out of Retirement To Bet Against Canadian Real Estate
Short
selling the 'marginal' lenders was what I liked about his approach. It
was 6 months ago that I posted this article. Showing the
patience needed to see an idea to 'fruition' but also how many shadow
lenders are operating in the mortgage market.
10/31/16
Shadow lenders growing in population
By WM
The number of mortgage brokers and non-bank
lenders operating outside of Bank of Canada’s reach is increasing,
including the likes of cash-for-jewelery dealer Harold Gerstel of
Toronto.
Gerstel, 57, owns a cash-for-jewelery shop in the Lawrence Manor
neighbourhood and has found arranging mortgages as another way to earn
dollars.
In his daytime commercial ads, he promises to seal a mortgage in five
business days for low-income borrowers. He adds that these applications
will require little documentation and a record of late payments.
The venture to mortgage broking appears to be fruitful for Gerstel, as
he has sourced hundreds of home loans since 2011 with lightly regulated
non-bank lenders.
“We arrange mortgages for the average Joe,” Gerstel said. “The banks are
very strict today. A lot of these people go to the bank and they get
refused. So they turn to the private market.”
This new industry of mortgage brokers and non-bank lenders is expanding
fast, but the Bank of Canada (BOC) warns homebuyers who deal with less
regulated lenders may come with a hefty risk.
“A sizable proportion of new, uninsured mortgages are being issued to
riskier borrowers,” the BOC report said. “Although less-regulated
lenders account for only a small share of overall lending in Canada,
stress experienced by one or several of these entities could have
adverse financial and economic spillover effects.”
Of all of the mortgages writing in Canada, about 5% come from
unregulated lenders. Eighty-percent of mortgages are created by
federally regulated lenders, including the country’s five biggest banks.
“A lot of this business falls out of the regulated space and into the
shadow banking or unregulated space,” said Martin Reid, president of the
federally regulated non-bank lender Home Capital Group Inc. “It may
become a bigger systemic risk.”
Despite the authorities warning against the likes of him, Gerstel is firm to pursue his second career.
“I’m always going to do a little bit of jewelry but I’d rather do
mortgages because there’s a lot of room for growth there,” he said.
“Every day there’s thousands of thousands of people that need
mortgages.”
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