Some quick notes on Home Capital

I don’t think that Home Capital is a great short at the moment due to the expensive borrow (>60%).  The expensive borrow and rising share price suggests a short squeeze.

However, I do think that there are serious issues with the company such as systemically poor underwriting.

  1. Underwriting is likely godawful.  The OSC statement against Home Capital alleged “phantom ticking”, a “systemic practice” at the company whereby underwriters would say that they verified incomes without actually doing so.  Given that Home Capital decreased volumes for both insured and uninsured mortgages following its internal investigation into its underwriting practices, it is possible that the underwriting issues weren’t limited to insured mortgages.
  2. Given the lack of income verification, it is unlikely that a subprime lender like Home Capital has lower losses than the big Canadian banks (which charge lower interest rates and turn subprime borrowers away).  However, Home Capital’s loan loss provisions are extremely low (0.13% as of the latest quarter and 0.03% in Q1 2016).
  3. Questionable board of directors.  According to the OSC statement, a vice president sent a memorandum to the Chair of the Audit Committee under HCG’s Whistleblow Policy in June 2015.  It seems to me that these issues were clearly explained to the board and they chose not to correct improper disclosure.  (Director James Baillie, the former OSC chair, did resign from the company’s board as announced in a July 27, 2015 press release.)  The board did not do anything about firing Robert Morton, who will be paying $500,000 under the proposed settlement with the OSC.  Note that Robert Morton remained the CFO and certified Home Capital’s latest interim financial statements that were filed on Sedar on May 11, 2017 (Robert Blowes became the CFO following that filing).  Insiders even had the chutzpah to issue the April 19, 2017 press release stating that the company “believes that its disclosure satisfied applicable disclosure requirements”.  Given the pending OSC settlement, that press release seems suspect.
  4. An anonymous short seller figured out an undisclosed related party transaction whereby Home Capital was transferring delinquent mortgages to a “Recharge Mortgage Canada”.  In response, HCG issued a August 24, 2016 press release stating that “Home Trust has not sold any loans requiring work-outs or restructurings to any third party,
    including Re-Charge Corporation, since September 2015”.  The Seeking Alpha report shows that mortgages were transferred from Home Trust (HCG’s subsidiary) to Recharge Corporation after September 2015.  Perhaps HCG insiders would like shareholders to believe that HCG sold perfectly good non-delinquent loans to Recharge.  However, the Seeking Alpha report goes into detail into explaining why that makes little sense, e.g. some of the documents are signed by a law firm associate who specializes in recovery services.

In summary, Home Capital looks like a poorly-managed business that could potentially disclose material weaknesses in its internal controls in the future.  And if you are on finance Twitter, you will know that HCG is trying to stave off a bank run.

*Disclosure:  While I have briefly shorted Home Capital in the past, I currently have no position in the stock.  I do not like shorting stocks where the borrow is above 10%.  High borrowing costs and significantly higher buy-in risk makes the attractiveness of such trades difficult to figure out.

Quick Links

Marc Cohodes has some good presentations on Home Capital.  In particular, the close ties between Home Capital and top brokers (who were later terminated following the underwriting probe) do not look good for the company.

The Financial Post has a timeline of the Home Capital saga.

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