Home Capital Slides as Investors Sound Contagion Warnings

  • Lender accused of failing to properly disclose internal probe
  • Home Capital and some former executives face fines, bans

Home Capital Group Inc.’s decline deepened as regulators began what is expected to be a lengthy series of hearings into allegations the company misled investors about its mortgage book, raising concerns about wider contagion to Canada’s red-hot housing market.

The hearing in Toronto Thursday was the first step in an inquiry into accusations made by the Ontario Securities Commission that Home Capital failed to properly disclose an internal probe into fraudulent mortgage applications. Home Capital has said the allegations are without merit and will be vigorously defended. The commission set a date of June 2 for the next hearing.

The OSC probe is the latest roadblock for the Toronto-based company, which has since seen its shares plunge, credit ratings downgraded and a run on deposits, forcing it to get a costly rescue loan. Observers including BlackRock Inc. have warned that if Home Capital’s woes are allowed to run for too long, it could endanger credit markets and Canada’s economy.

"The focus now is on the potential for a systemic issue across the economy and it would be folly just to ignore that," said Aubrey Basdeo, head of local fixed income at BlackRock in Toronto.

Home Capital fell 10 percent to C$6.23 in Toronto trading at 3 p.m. The stock has now dropped 72 percent since the OSC allegations were made public April 19, reducing its market value to about C$400 million.

Though Home Capital accounts for just 1 percent of the Canadian mortgage market, its woes are being closely watched by investors and regulators concerned about possible contagion to other lenders and to the wider housing market. Rival Equitable Group Inc. was forced to turn to six commercial banks for a C$2 billion credit line to counter a run on deposits. And with household debt at record levels and prices soaring in Toronto and Vancouver, Home Capital’s troubles could spark a downturn in the real estate market.

Home price gains in Toronto slowed to 25 percent in April from a year earlier, as listings jumped by the most in seven years, signaling early signs of a slowdown, according to Toronto Real Estate Board figures released Wednesday.

"I don’t think Home Capital represents the canary in the coal mine that’s going to be the first crack in what would ultimately be a crash in the market or a financial crisis," said Craig Fehr, Canadian investment strategist at Edward Jones. "What I do think is it puts an additional spotlight on the housing boom that is occurring. That in and of itself can start to slow housing market activity."

Canadian Finance Minister Bill Morneau has been monitoring the Home Capital situation “very closely,” as has the Office of the Superintendent of Financial Institutions, according to statements this week.

Home Capital and some of its former and current executives could face sanctions, including fines of as much as C$1 million ($730,000) per breach of securities law, and bans on future activity such as sitting on a corporate board, if found to be in violation of securities law or acting in a manner that is contrary to public interest.

Investors pulled about C$1.6 billion of deposits from Home Capital in a month. The firm secured an emergency C$2 billion loan from Healthcare of Ontario Pension Plan and it has pushed back earnings to May 11 as its seeks to stem the flow on deposits. The company has also hired banks for a possible sale.

Home Capital will be represented by Edward Waitzer at Stikeman Elliott LLP. Waitzer was chair of the OSC from 1993 to 1996.

Details of the allegations:

  • OSC alleges that Home Capital failed to properly disclose its internal investigation, which found that brokers who originated C$881.4 million in 2014 had falsified income information and that its underwriting department had failed to detect the fraud.
  • “HCG made materially misleading statements, blaming the decline in originations on external vagaries such as macroeconomics, seasonality and competitive markets,” according to the OSC’s statement. “Within HCG, it was known that the decline could not be attributed solely to the external factors HCG outlined in its public disclosures.”
  • OSC alleges Home Capital founder Gerald Soloway and former president Martin Reid made misleading comments to analysts on an earnings call. Former chief financial officer Robert Morton is also named in the statement of allegations.
  • OSC alleges that Home Capital did not disclose details on its investigation or termination of brokers until July 2015, even though the company knew in February, and that the disclosures were not sufficient for the reader to understand what actually happened or the impact.
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