The rapid decline of Home Capital Group, Canada’s largest alternative mortgage lender, is already an event of historic proportions.
But some market observers fear the drama could cause investors to lose confidence in Canadian lenders as a whole, which could damage the health of the country’s financial system.
“Home Capital contagion has spread to the entire mortgage market, in particular, alternative mortgage lenders,” analysts at National Bank of Canada wrote Thursday, amid falling share prices and deposit withdrawals.
That has some worried about the troubles spreading throughout Canada’s financial system — a risk that even the most bearish investors admit remains remote, for now.
“The probability has gone from infinitesimal to possible — unlikely, but possible,” Jim Hall, the chief investment officer at Mawer Investment Management, told Bloomberg News over the weekend.
“If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”
The idea of a systemic crisis in Canada’s financial system seemed almost laughable not long ago. For years after the financial crisis of 2008-09, Canada’s banking system was lauded as one of the most stable in the world. The country was congratulated on avoiding the sort of irresponsible lending that led to the U.S.’s housing crisis last decade.
But Home Capital’s troubles — which began with an investigation into dozens of brokers who allegedly falsified mortgage applications — has shaken investors’ confidence in Canadian lending.
If enough investors pull out their money, lenders will have a harder time accessing the money they need to lend out mortgages. That, in turn, could raise mortgage rates and make it harder for some people to get a home loan.
Home Capital's plunge snares other lenders
As Home Capital’s share price tanked last week (it ended the week down 53 per cent) it dragged down other lenders with it. Shares in Equitable Group, another major alternative lender, fell by 40 per cent in the space of several days, the Globe and Mail reports.
The lender experienced a run on its deposits, but on a much smaller scale than Home Capital. Equitable lost about $75 million in deposits last week, an “elevated but manageable” 2.4 per cent of the total.
The company’s shares bounced back Monday, in the wake of a strong earnings report and an aggressive campaign by Equitable executives to highlight the fact that Home Capital’s problems are its own.
“Those issues are unique to [Home Capital], and it’s unfortunate that banks, including ourselves, are drawn into the mix, particularly since our approach to bank governance and our internal controls are vastly different, and the fundamentals are only getting stronger,” Equitable CEO Andrew Moor said.
Equitable’s stock price started the week off strongly, up 26 per cent as of 1 p.m. ET Monday, recovering some of the previous week’s losses.
Not so for Home Capital, which saw its shares drop once again as it announced it was drawing $1 billion from a $2-billion lifeline it secured last week. Shares were down about 10 per cent of as 1 p.m. ET Monday.
The depth of Home Capital’s troubles is dizzying: High-interest deposits at the lender have dropped by some 72 per cent in the space of a week, in what has essentially been a bank run. The company’s high-interest savings accounts now hold $391 million, down from $1.4 billion a week earlier.
The terms of the company's $2-billion line of credit sent many investors fleeing. Home Capital will be paying 10 per cent interest on any funds drawn from the line of credit, while earning a fraction of that on its mortgage loans. That, as much as anything, led to the 53-per-cent decline in its stock price last week, and to a downgrade of its credit rating.
Betting against Canada's financial system
Not even Canada’s big banks are entirely safe from investors’ jitters. Shares of all big six banks fell last week, and the Globe and Mail reports that bets against Canadian financial institutions are at elevated levels, compared to historic norms.
The Home Capital debacle may already be affecting the larger banks' plans. Bloomberg reported Monday that a shareholders' advisory firm has recommended against CIBC's planned takeover of Chicago-based PrivateBancorp Inc., citing the Home Capital crisis as one of the reasons.
Around the world, many bearish investors have placed money against Canadian banks and real estate, betting that high house prices and heavily-indebted households will result in a market correction. Until Home Capital’s troubles began, that was often a losing bet.
But experts point out that, for the time being, it’s only Home Capital that has shown signs of genuine financial difficulties, and there are regulations in place in case the trouble spreads.
“It’s a pretty hot fire in one little corner of the forest, and it doesn’t look like it’s spreading,” Hall told Bloomberg. “There are firefighters standing around it right now, so if it starts to move, they’ll put it out.”
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