What Analysts Are Saying About Home Capital's Warning Shot

  • Embattled lender includes ‘going concern’ reference in report
  • Management warned of ripple effects if company doesn’t recover

Home Capital Foe Reveals Extent of Bet Against Lender

Beleaguered Canadian mortgage lender Home Capital Group Inc. posted its first-quarter results after the close of markets Thursday -- and the “slight dip” in profit and revenue was the last thing on anyone’s mind.

The company’s shares are down as much as 20 percent after management said during a conference call Friday that asset sales aren’t likely to happen any time soon and more collateral needs to be pledged than expected. In the quarterly report, the company also confirmed what was widely speculated, they share concerns about Home Capital’s ability to continue as a going concern.

A run on the company’s deposits in the wake of allegations from the Ontario Securities Commission on April 19 led to a severe selloff in the shares, forced the company to take an expensive line of credit to meet its near-term obligations, and hire advisers to evaluate its strategic options, including a potential sale. There have been a few recent bright signs, however: CIBC Asset Management more than tripled its stake in April, while top shareholder Turtle Creek Asset Management boosted its holdings to more than 15 percent of the company.

Late Thursday night, the alternative mortgage provider also released a filing detailing the terms of its $2 billion credit facility with a syndicate led by the Healthcare of Ontario Pension Plan, which turn out to be more onerous than previously thought.

During the conference call on Friday morning, management warned that significant "knock-on effects" would ensue if the company failed to recover.

Here’s what analysts are saying about the quarterly results:

Laurentian Bank

Marc Charbin (Hold, price target cut to C$11 from $C28):

“Deposits continue to decrease for HCG without any evidence of a turnaround. HCG has highlighted that $2.7B of deposits are due in the next three months and a further $4.3B in the next nine months. It appears as though asset sales are the priority to satisfy deposit outflows so that HCG can maintain a level of renewals and originations that meet more narrow underwriting criteria. Cash flow is being managed daily and surely will be disclosed in the coming weeks along with new funding sources.”

National Bank Financial

Jaeme Gloyn (Underperform, price target C$6):

“We continue to see material risks related to each new development, in particular HCG’s ability to attract new deposits, raising significant concern with viability of the existing business model. With that in mind, we revisit the next steps for Home Capital, in chronological order as we see it: 1) Continue operating the company as is, 2) Explore an originate to sell business model, 3) Solicit asset sales, and 4) Regulatory resolution.”

Scotiabank

Phil Hardie (Rating under review)

“Given significantly reduced earnings visibility and diminished ability to confidently quantify the numerous stacked risks involved, our rating remains Under Review. The stacked risks include: (1) execution risk in an operational turn, (2) executive management transition, (3) regulatory, (4) a late cycle and transitioning housing market, and finally (5) the higher funding costs and ability to attract sufficient cost-efficient retail deposits to fund loans. Due to regulatory involvement we do not expect to gain much clarity on issues related to the OSC allegations.”

TD Securities

Graham Ryding (Speculative buy, price target C$15):

“Results shed little insight towards near-term outlook…The company acknowledges there is material uncertainty regarding its future funding capabilities and ability to continue as a going concern.”

RBC Dominion Securities Inc.

Geoffrey Kwan (Underperform, price target C$8):

“We believe investors may be concerned that the over-collateralization is higher than what they may have initially believed. Given there is no penalty to cancel the facility, we think it makes it that much more important for HCG to secure funds (e.g., alternative funding facility with better terms, asset sales) to cancel the facility. While the credit agreement answers some of our questions (e.g., there is no penalty/premium if HCG wants to permanently cancel the credit line), it is unclear what mortgages qualify for the security backing the loan and whether it’s a broadly diversified pool of mortgages or whether the mortgages used for security backing the credit line might be the highest credit quality mortgages in HCG’s mortgage book. More broadly speaking, with one of HCG’s competitors getting a $2B credit line from a syndicate of the Big Six Canadian banks at more attractive terms than HCG’s credit line, is this a potential funding source for Home Capital?”

Industrial Alliance Securities

Dylan Steuart (Hold, price target C$.9.50):

“Ironically, the view as of March 31 looked promising: Loan originations of $2.3B were up 32% from a year ago, and loans on the balance sheet were up 3.5% YoY. Of course, given the events subsequent to quarter-end, little of that is consequential to the prospects going forward… While the going concern disclosures and the increased collateral identified against the credit line could raise some eyebrows, very little in the quarterly disclosure changes the challenges going forward.”

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