Short-Seller Nailed Home Capital, Then Got Stung by Buffett

Marc Cohodes was having dinner Wednesday with a friend at the Slanted Door, an upscale Vietnamese restaurant on San Francisco’s Embarcadero, when he saw the news: Warren Buffett’s Berkshire Hathaway Inc. had just thrown a lifeline to Home Capital Group Inc.

“I said, ‘Boy, that’s interesting,”’ he remembers. “I’m surprised Berkshire Hathaway would show up in something like this.”

It was a mild reaction for an investor who’s shown time and again he’s got brass. More than anyone, Cohodes has tried to discredit Home Capital. A former hedge fund manager and veteran short seller, he began betting against the stock in 2014, publicizing his view that the Canadian mortgage provider had lax underwriting and poor management.

It didn’t take long for the wager to net returns. Two years ago, the company said it found fraudulent data in documents provided by partner brokers who submitted about C$2 billion in mortgages. The lender cut ties with them, prompting a lower profit forecast.

The troubles didn’t end there. The Ontario Securities Commission alleged in April that company executives had misled investors about the extent of the mortgage fraud. Clients began withdrawing funds from savings accounts. From its peak in 2014, Home Capital stock fell about 90 percent.

Cohodes seemed to be riding a wave of vindication. So many other investors piled into the trade that, at one point, almost two-thirds of Home Capital’s shares were sold short.

Stock Rebound

In recent weeks, though, things started to turn around. The stock began to climb on news of asset sales and partners willing to invest in the mortgage lender. The company and former executives settled the regulatory probe this month.

Then, late Wednesday, the bombshell: Berkshire agreed to take a 38 percent stake in the company for about C$400 million ($300 million) and provide a line of credit. Home Capital’s stock rocketed 27 percent on Thursday to C$19. The shares added another 43 cents as of 9:52 a.m. in Toronto.

“Partnering with an investor with the pedigree of Berkshire should go a long way in restoring confidence, particularly with depositors,” Dylan Steuart, an analyst at Industrial Alliance Securities Inc., said in a note Friday. “This transaction, combined with the recent settlement with the OSC, will likely lead to funding inflows as the smoke continues to clear.”

Few investors would want to be on the opposite side of such an economic force. But Cohodes isn’t backing down. He said he still thinks Home Capital’s stock could go to zero and that he continues to bet on a decline, though he won’t disclose the size of his wager.

“I may lose,” he said in a phone interview on Thursday, while pacing around his his chicken farm about an hour north of San Francisco. “It may go to C$20. It may go to C$30. But I’m in a whole lot higher. I’m willing to see more rounds.”

Desperate, Horrible

Cohodes says he takes comfort in the way the deal with Buffett was structured and believes there’s a scenario where both he and the billionaire can make money. In addition to getting discounted shares in Home Capital, Berkshire agreed to provide a C$2 billion credit line that will eventually carry a 9 percent interest rate, generating returns for Berkshire even if the lender’s shares slump. Cohodes sees the deal terms as a validation of his skepticism.

“This move shows how desperate this thing really is,” he said. “If it weren’t Warren Buffett’s name, it would be destroyed today, just absolutely destroyed, because it’s that horrible of a deal.”

Home Capital declined to comment about Cohodes, but said in its statement Wednesday that the Berkshire investment was a “very strong validation and endorsement.” In the same announcement, Buffett added that Home Capital was a good bet because of its “strong assets, its ability to originate and underwrite well-performing mortgages, and its leading position in a growing market sector.”

Buffett, 86, has spent decades building Berkshire’s reputation as a source of capital for troubled companies. During the 2008 financial crisis, he plowed billions into Goldman Sachs Group Inc. and General Electric Co. He also propped up Bank of America Corp. when that lender ran into trouble in 2011. In exchange for putting money and his reputation on the line, he’s negotiated preferential returns for Berkshire shareholders.

As with those previous deals, Berkshire moved quickly with Home Capital. For Cohodes, who’s spent years digging into the mortgage lender, that’s another sign that his thesis may still be right.

“I got the goods,” he said. “I’m not wrong just because he shows up.”