Inside Canada’s Push to Contain the Fallout From Home Capitalby
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.
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.
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.
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.”