Home Capital

One of the most recent and frightening developments on the Canadian real estate scene is the destruction of Home Capital. Home Capital is referred to as an alternative lender, it lends money to house buyers who otherwise do not qualify for a residential mortgage from traditional lenders. In other words, these are high-risk mortgages. Home Capital earns a high rate of return on its funds as a result of higher mortgage rates and a host of fees that it charges borrowers as a revenue enhancement strategy. Its borrowers have generally paid up for the privilege of having a Home Capital loan. No doubt about it.

Here is an article from the Financial Post looking at the further deterioration in the Home Capital situation: Home Capital shares shed another 11% after withdrawals top $1 billion in one week. Lack of confidence in a financial institution can spread like wildfire. There are many analysts saying that this cannot happen to the major Canadian banks as the Canadian government would step in to save them. This goes back to the “too big to fail” argument that we heard from the Americans in 2007/2008. The stock market has spoken with the recent decline in major bank shares in Canada.

Missing the point

For the most part, many of these analysts are missing the point. It’s not about the banks, it’s about the borrowers. Some writers have pointed out that the impact of the demise of Home Capital (and its almost twin sister the Equitable Group which is still out there for now) is the impact on borrowers. A lot of the speculation in housing prices is ultimately being fueled by the ability of house buyers to tap alternative sources of funding. In the absence of funding, the whole thing grinds to a halt. And as I mentioned before, it doesn’t take a thousand houses to change the price. All it requires is one distressed borrower who needs to lower the price from current market levels to dump a property. So it’s arguable that we are on the cusp of something different. And these changes happen when we least expect them, that is the nature of bubbles.

Home Capital Group Inc.’s shares plunged nearly 65 per cent on Wednesday, pulling down the stocks of other alternative mortgage lenders along with it. Here’s a look at the company, its role in the Canadian mortgage landscape and how the discovery of fraud among its brokers two years ago continues to have ripple effects today.

This comment in the Financial Post is what regulators need to worry about and how widespread the practice is. To think that the major banks have not funded suspect mortgages is ridiculous. The “moral hazard” created by CMHC (government mortgage insurance) is real. The level of due diligence of the major Canadian banks rests heavily on their ability to fund government insured mortgages.

We don’t need thousands of bad mortgage loans to crater the market. Remarkably few will achieve that goal, particularly if it results in a crisis of confidence. Alternative lenders such as MCAP and First National Financial are seeing their stock prices bounce around (MKP has taken a ten per cent hit in the last few days as a display of waning confidence). Equitable Group’s share price has been all over the place.

Stay tuned, there is more to come here as the saga continues. All the market needs is the revelation of fraud (even small scale) and the whole thing will tank.