Broker Fallout Questions Dog Canada’s Home Capital

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Home Capital Group Inc.’s battle with short sellers comes to a head Wednesday when the Canadian mortgage lender reports earnings, with analysts seeking more details on the impact of its split with brokers.

The country’s largest alternative mortgage provider disclosed July 10 that traditional mortgage originations fell 16 percent to C$1.29 billion ($990 million) in the second quarter and insured single-family mortgages plummeted 55 percent as it dumped brokers that didn’t meet its standards. The stock has dropped 31 percent since then, as short interest rose to a near record.

“How many brokers did they cut ties with and how much did they account for in originations?” Bradley Safalow, founder of independent research firm PAA Research in Atlanta, Georgia, who has recommended clients short the stock, said in an e-mail Monday. “It’s a simple question they should have the answer to. This is a sin of omission on their part. It suggests they don’t necessarily have their arms around the extent of the problem, in which loan products, and for how long.”

Toronto-based Home Capital has been a target for short-sellers in recent years as its share price surged with Canada’s hot housing market. Groups from the International Monetary Fund to Fitch Ratings Ltd. have said the market is overvalued as prices in Toronto and Vancouver reached records.

Dropped Estimates

Martin Reid, Home Capital’s president, declined to comment on performance and the short sellers through spokesman Boyd Erman. The company, which gets its business from about 4,000 brokers across Canada, said in its July statement that originations had been impacted by “among other things, its ongoing review of its business partners, its conservative approach to growing its residential mortgage business and the competitive market for prime insured mortgages.”

Analysts dropped their estimates for where Home Capital stock will be in 12 months to C$41.33, down from a forecast of C$51.95 on July 27 last year, Bloomberg data show.

Safalow has a target price of C$25 for the stock as of July 22. The stock closed at a two-year low of C$29.15 Monday and was down 5.8 percent to C$27.47 at 11:17 a.m. in Toronto.

Short interest reached 30 percent of its free float on July 24, close to a record 36 percent in 2013, according to Markit data.

“Weaker macroeconomic backdrop and surprises from Home Capital have raised investor concerns,” Phil Hardie, a financial analyst at Bank of Nova Scotia, said in a July 20 note to clients. “This concern appears to have played out in recent months with a dramatic increase in short interest” in Home Capital and Genworth MI Canada Inc., the country’s biggest mortgage insurer.

Earnings Forecast

Home Capital is set to report second-quarter profit of C$1.03 a share, according to the company’s July 10 disclosure and subsequently the estimate of nine analysts surveyed by Bloomberg. Three months ago, analysts forecast C$1.09 a share, before the company disclosed lower originations. Earnings were C$1.05 a share in the same quarter last year.

“What I’m not sure about is exactly how much of their business has been curtailed by the termination of these broker relationships,” Shubha Khan, analyst at National Bank Financial, said by phone July 27. “There will be a lot of questions on the conference call.”

The statement pre-releasing profit was vindication for Marc Cohodes, once a short seller at U.S. hedge fund Copper River Management, who’s been shorting the company as a private investor since November.

California Farmer

“Home Cap is not a ’too big to fail’ institution,” said Cohodes, above the sound of chickens on his farm in Cotati, California. “What’s going to happen is people’s estimates of their business are too high and estimates are going to come down.” He declined to say what price he’s betting the stock will fall to.

Cohodes, 55, has been watching the stock since June 2013 when investor Steve Eisman, who bet against subprime mortgages in 2007, said at a conference Canada’s housing market was due for a correction and the company would be hit hardest. Shorts on the stock then reached a record.

Two years later, Canada’s average home price has rallied 11 percent to C$497,300; Home Capital has risen 5 percent, and Eisman closed his Emrys Partners fund to join Neuberger Berman Group.

Home Capital reports results after the market close Wednesday, with a conference call scheduled for July 30 at 10:30 a.m.

Separately, Home Capital said late Monday that James Baillie, an independent director since 2012, resigned effective July 24 for “a variety of personal reasons.” The company expects to name a replacement in the third quarter, according to a statement.

Other recent departures from the company include former Chief Financial Officer Robert Blowes, who retired at the end of 2014, and Marissa Lauder, who led the teams responsible for risk.

In a sign of the reverberations the Home Capital announcement caused, First National Financial Corp., a Home Capital competitor, highlighted mortgage underwriting standards on its second quarter conference call in response to several analyst questions. Executives said short sellers should be cautious as Canada’s housing system isn’t modeled after the U.S.

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