Home Capital / Equitable Group discussion

Home Capital (TSX: HCG) collapsed 60% on news that they are in the process (not obtained!) a secured credit facility for a 10% interest rate, and a 2.5% standby rate for the unused portion. They also announced that customer deposits have collapsed in recent days.

Needless to say, this is a huge amount of interest to be charged and the market’s reaction is fairly indicative of this being a very, very negative event for the company.

(Update, April 29, 2017 – This is a little late, but the company confirmed the secured credit facility on April 27, which including the $100 million commitment fee, means an effective rate of interest of 15% for a $2 billion borrow, or a 22.5% rate for a $1 billion borrow. The ex-chair on television said it was secured 2:1 by mortgage loans and is front-in line. Yikes!)

Equitable Group (TSX: EQB) also has collateral damage, down approximately 17%. Are they next?

No positions.

20 thoughts on “Home Capital / Equitable Group discussion”

  1. MIC down about 8% and FN about 10%. EQ now 17% and HCG 63%. Wonder how much overlap there is between all these companies.

  2. @Marc: The question here is… when you do you sell on what is, 24 hours after, a good gamble?

  3. I live in Asia, so I’m only awake for the first 3 hrs of the market. I probably would have sold at 8.25 for a quick 15% gain……but I was not up and did not set a sell order……and it really isn’t a lot of money.
    Anyways, when the drop first occurred (on the 26th) it went to 8.15……and I missed it…then it started to rise quickly and I picked up 200 at 9.00….. watched it quickly go to 10….then down to 7.25 even quicker……oh well, time for bed, put a lowball 300@6.10 bid in and it got filled.

    Td has lowered there price to 15
    RJ has lowered there price to 10
    Also this came over the wire…..
    “Dylan Steuart, a financial services analyst at Industrial Alliance Securities, said its shares could be worth C$13.50 if the company is able to hire an experienced management team to replace those tarred by the OSC’s allegations and stem the outflow of deposits.”

    Any thoughts…..from anyone?????
    Also FN and FC have have hit 52 week lows, don’t know much about them, but I know their involved in mortgages.
    Are we talking buy opportunities, not yet buying opportunities, value traps or falling knives???

    Cant believe only you and I in this “discussion ” Sacha…..I have read some quite insightful comments from others on this blog before.

  4. Main question is how much their asset portfolio is worth. If short seller Marc Cohodes is right, there will be huge (5 bn) impairments as their underwriting is based on fraud. In that case, the equity is worthless.

    Supporting that view is the 2bn lifeline at absolutely preposterous rates from the HOOPP pension fund (generally stupid money), of which its CEO has a blatant conflict of interest.

    HCG is funded 3/4 with deposits, of which 60% payable within a year (nearly 7 bn), yielding an avg 1.9%. That rate is an order of magnitude smaller than the lifeline rate. That doesn’t seem sustainable in any way. And there is no business model in borrowing at 15-20% and lending at 4%.

    Sell side says: if another party takes over the portfolio and funds at low rates, it’s very profitable. Yes, could be, but that takes us back to the main question what the assets are worth. GMP says “we still have not seen anything that calls into question the integrity of book value”. If you bury your head in a pile of annual reports, no. Otherwise, alarm bells are ringing all over the place.

    I wouldn’t read to much in short term stock movements.. with an extremely high borrow rate (currently at 44% with Interactive, up from 22% a week ago and having been at 50% on Thursday), one can expect some short covering after a huge fall as it’s very expensive to wait for the shoe to drop to zero completely.

    Very interesting to see what happens as a spectator, but I wouldn’t touch it. As Sacha said, it’s a gamble. Observing as an outsider from Europe, Ontario real estate currently looks to me as obvious a bubble if there ever was one. And HCG a text book case train wreck.

  5. I do have quite a few thoughts about this, there is part financial and part psychology.

    Just note the effective interest rate of this credit facility is 22.5% if they keep $1 billion drawn, or 15% if they draw the whole $2 billion.

    The financial side is obvious – as @Thijs was saying, it is impossible to make money when your cost of capital is 15%. I would also love to know how much of their GIC portfolio is due in 3 months vs. 9 months, etc. Two billion is probably management’s top-line estimate of how much of their deposit base will evaporate, but we will see for sure.

    Psychology-wise, the mortgage portfolio is worth book value if property values rise and even the people that submitted fraudulent documentation could refinance on the basis of equity-to-loan values. The question then becomes a bet on real estate prices underlying the mortgage portfolio.

    This also affects FN, FC, EQB, etc. FC is an interesting case since their debt isn’t showing any sign of distress whatsoever – they have 83% exposure to Ontario and a $450 million mortgage portfolio. They are capitalized roughly with half-debt, half-equity.

  6. The other thing I forgot is that it is pretty evident that most trading right now is probably dominated by short-selling covering up – I can’t see how somebody short on this thing would want to continue holding (or heaven forbid, adding to their position) with the borrowing cost that is currently being charged. The option markets have also gone completely crazy on HCG, implied volatility is crazy – over 200% on front months.

  7. Shorts are probably betting that it will probably not take more than a couple of weeks to blow up.

    The $ 2.5 bn in demand deposits is probably all gone. Given an equal maturity spread over the year of the close to $7bn in additional <1y deposits, we should be looking at close to $ 0.6 bn on a monthly basis. So a $ 2 bn lifeline – make that $ 1.9bn – with $ 1.2 bn in cash will provide for a month tops if the deposits leave.

    The coming weekend will already be very interesting, hard to imagine no new developments on Monday.

    Implied volatility is high, but then realized volatility also is – 200% to 300% implied corresponds with 1 standard deviation daily moves of 13% to 19%. The 30-day realized volatility is 321% (as per m-x.ca).

  8. Looking at the 2016 year-end report, as of December 31, 2016 they have $2.03 billion in GICs payable April 1 to June 30, and $3.27 billion payable July 1 to December 31, 2017. This is offset by a not-inconsiderable $7.64 billion in mortgage receivables in the same timeframe.

    Their next quarterly report will be looked at by a lot of eyeballs, to say the least.

  9. Marc, even without the power of hindsight, I think you traded this one very well. I’d take a guess that you sold your shares to a short trying to cover up. Once enough of that rotation occurs it’ll probably leg down again.

    I’m trying to think of any company in my mind that did a secured financing at 15%+ that actually recovered with their equity intact (i.e. no intensely dilutive recapitalization). Can’t think of any off the top of my mind.

  10. My initial thoughts when the announcement came out was of Berkshire’s numerous deals in 2008-2008 with BOA, GE, GS and others. While most of those were at 10%, Harley Davidson was reach 15% if I recall correctly. Mind you, it is the second element (recapitalization) which I am unsure of.

  11. My gut instinct here says that HCG equity goes to zero, or has a very low buyout (i.e. similar to Bear Stearns’ buyout by JP Morgan, assisted by the Fed, for $2/share which was later revised to $10/share).

    The question is the ripple effect. I would think Equitable has to announce something at this point.

    I’m also surprised this hasn’t affected other deposit-based financial organizations, but we will see.

    Either way, this means that mortgage credit across Canada is going to be more difficult to access and this probably represents a cap on price appreciation, which does not bode well for those dependent on refinancing.

  12. HCG is definitely a speculative play…….I think they will be bought at at least 10 CAD. There is no proof (yet) that their mortgage are in anyway toxic. The problem obviously is Joe Public no longer trust them and wants their HISA and GIC money back. This IMO opinion leaves a great opportunity for a big player to step in and back stop them. If they come in right away, they will have to pay more/share, but that would probably assure Joe Public to leave his money in place. The play may be to let HCG bleed some more and pick them up much cheaper but then they wouldn’t be signing any more mortgage business.
    I also think there is a lot to this 2B loan that we don’t know about……The 100 million up front leads me to think there is a backdoor for someone to come in and takeover or re-issue a bigger loan without penalty….the 100 million being the only cost of having the health board come in and rescue.
    Its all way above my paygrade.
    Sacha….I hope your right about the shorts…..I will take a small position again under $5.00 for this speculative play.

  13. Marc, let me rephrase things. Let’s pretend you were given the opportunity to invest in their credit facility on the same terms as presented (and this loan was marginable to boot). I think almost ANYBODY would be putting a large chunk of capital into it – so clearly 2:1 collateral with the mortgage portfolio is sufficient security.

    There is a real liquidity component (i.e. HCG needs money NOW) which they are paying dearly for which everybody believes is real in light of the HISA meltdown. The question is solvency, is HCG’s gross mortgage portfolio minus $41.7 million in credit loss allowances worth what it is said?

    Each percent the mortgage portfolio is unrecoverable is nearly 10% of the company’s book value.

    Serious write-downs are quite likely in the event that mortgagers can’t renew (due to fraud), but I can’t shake the fact that real estate appreciation would make renewals a lot easier. It’s one thing if the market (let’s just cut to the chase and call “the market” Toronto) was crashing right now, but it’s another thing in its current state when it has appreciated 50% over the last three years or so.

  14. Sacha agreed, but I think that’s pretty much a hypothetical standpoint. If US home prices wouldn’t have declined, we wouldn’t have Lehman etc.

    Toronto prices are fully out of whack and they will come back to earth. Only question is who will be the greater fool bag holders.

  15. Jim Hall at Mawer Investments had this to say……if you haven’t already read it

    According to Bloomberg, Mawer CIO Jim Hall is recalculating the odds of a contagion widening across the Canadian financial system.

    “The probability has gone from infinitesimal to possible — unlikely, but possible,” said Hall, chief investment officer of the Calgary-based money manager, in an interview Saturday. “If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”

    “The assets look, at this point, still reasonably good,” Hall said, adding that Home Capital’s problem is a matter of confidence. “Confidence was lost in this company and the business model breaks apart. That’s the problem with banks.”
    ….but he sold 2.8 million shares at a big loss no doubt…lol.

    As a side note, Ive had in excess of 50% of my nut parked at Mawer 104 Balanced Fund for over 10 yrs….and its returned over 7% (average taken from there site). I consider it a swan (sleep well at night) investment.

    Will we see investment opportunities open up (non-speculative) in the banking sector??? …..I pulled out of all banks in June 2016……much to my regret, leaving 20% on the table.

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