Home Capital rebuilding mortgage pipeline, but challenges remain

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Executives at Home Capital Group Inc. say they are entering a new phase in the company's recovery, promising to gradually turn on the taps and increase the flow of new loans it is underwriting.

The steep costs of securing emergency financing amid a crisis of confidence and a run on its deposits earlier this spring, as well as cleaning up a mess of concerns over apparent fraud by some brokers in its network, pushed the beleaguered mortgage lender to a $111-million loss in the second quarter.

But on his first official day as Home Capital's new chief executive officer, Yousry Bissada stressed that Home Capital's "nucleus is strong." With deposit flows returning to normal levels, a revamped management team in charge and backing from famed investor Warren Buffett, Home Capital is taking the first steps to draft a strategy that will determine the size and shape of the business for years to come.

For the foreseeable future, however, the lender is still expected to be buffeted by an array of headwinds that are likely to slow its progress. Its mortgage portfolios are diminished by the crisis, and attempts to rebuild them will be constrained by the company's need to bring down its funding costs while still attracting deposits. New regulations aimed at cooling Canada's hot housing market present a material threat to Home Capital and other alternative mortgage lenders. And the company continues to draw added scrutiny from brokers, suppliers and regulators.

"We still have a lot of hard work ahead of us, but it's going to be a different kind of challenge," Mr. Bissada told analysts during a conference call on Thursday. "We're in a position where we can look forward and make fresh decisions about the kind of company we want to be."

After warning in May that its ability to continue as a going concern was in jeopardy, Home Capital now says it has enough liquidity and credit to stay in business for the foreseeable future. But restoring a measure of financial stability was expensive.

The company swallowed nearly $234-million in pretax expenses in the second quarter, which ended June 30. Costs included $130.6-million in upfront fees and interest on an emergency loan to prop up the business as its liquidity was drying up in the depths of the crisis.

Home Capital recently paid down the outstanding balance on a $2-billion credit facility provided by Berkshire Hathaway Inc., Mr. Buffett's firm, relieving it of the need to make onerous interest payments. But it also spent about $7-million in the quarter settling a dispute with the Ontario Securities Commission and a class-action lawsuit.

"While all of these steps were deliberate and necessary, we did incur significant costs," said interim chief financial officer Robert Blowes.

The funding crisis dented Home Capital's core business: Traditional single-family residential mortgages declined 6 per cent in the second quarter to $10.7-billion, from $11.4-billion at the end of the first quarter. "This is mainly due to a steep decline in originations during the second quarter," Mr. Blowes said.

Since then, "we have revised our lending criteria," boosting interest rates on its loans to get a better return, Mr. Blowes said. "We've started to rebuild our mortgage pipeline."

The company stressed that it hasn't loosened its risk appetite and has tightened controls on internal procedures, adding extra coaching for staff and adjusting incentives to focus less on volume.

Higher mortgage rates still weren't enough to offset the cost of offering more generous interest rates on term deposits and savings accounts to lure depositors back. Home Capital's rates are 50 to 70 basis points higher than it would like, and the company plans to begin reducing them in the coming weeks.

But it can't move too fast: About $1.6-billion in fixed-term deposits are set to mature in the third quarter and need to be replaced. "It's probably going to take six months for us to understand where we're going to be able to function in the deposit market and in the lending market," Mr. Blowes said.

As Mr. Bissada, the new CEO, sets about building a strategy through the fall, the country's housing market is still plagued by uncertainty. Canada's banking regulator has proposed tighter rules on mortgage underwriting, including tougher stress tests on uninsured mortgages. The new regulations, if implemented, "could well have a material impact on our business strategy going forward," Mr. Blowes said.

And on Sept. 12, shareholders must vote on whether to allow Berkshire to purchase the second block of its proposed equity investment at a steep discount, further diluting existing investors' stakes.

"We continue to recommend investors await better visibility on [Home Capital's] performance as well as on macro risks," Jaeme Gloyn, an analyst at National Bank Financial Inc., said in a research note.

Home Capital's share price fell more than 5 per cent in early trading on the Toronto Stock Exchange on Thursday, but rebounded somewhat, and was down less than 2 per cent shortly after 11 a.m.