HCG.to - Home Capital Group

[KCLarkin]

I'm not going to do a full write-up on this unless it drops a bit further. I just want to move any discussion off a different thread.

 

Long thesis:

- Incredibly well-run Canadian bank with 20% ROE, growing 15% per year. 10x P/E.

 

Short thesis:

- Sub-prime lender exposed to a housing bubble that will soon collapse. (Plus Canada is in trouble due to tumbling oil prices, weak employment, weak dollar, etc).

http://www.bankofcanada.ca/wp-content/uploads/2011/06/sp150611.pdf

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/shorting-the-housing-bubble-in-canada/

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/canadian-housing-bubble/

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/canada-housing-sentiment/

 

Disclosure:

No position. I don't trust management anymore.

[KCLarkin]

Due North: Canada’s Marvelous Mortgage and Banking System:

http://www.aei.org/publication/due-north-canadas-marvelous-mortgage-and-banking-system/

[Guest Schwab711]

Due North: Canada’s Marvelous Mortgage and Banking System:

http://www.aei.org/publication/due-north-canadas-marvelous-mortgage-and-banking-system/

 

People act as if Canada's population is more fiscally responsible and somehow better at paying their mortgage. The last 5 years they have avoided a housing downturn due to a near 100% growth in consumer debt levels. Housing prices to Income is increasing and over 5 vs. 2.2 in the US (and decreasing). Retail debt levels cannot increase any further without even more risk, Canada has to experience a serious recession or start growing at 4%+. Jobs are around 0-25k each month and decreasing. This looks like a bubble that seems likely to pop. I hate calling bubbles in anything, especially some market I've never even participated in. I did used to work as a financial analyst for one of the 4 banks and I thought this was a bubble 3 years ago when the leverage numbers were significantly lower. Something to keep in mind as their economy has significant amount of debt and is highly levered to commodity prices.

[Liberty]

I wouldn't touch anything that exposes me directly to the canadian housing market, especially not at this point (super high debt levels, houses almost costing twice what they cost in US, oil crashing, mining doing badly for years, US economy doing better which means Canada might be forced to follow US in raising rates at some point even if things are worse here, etc). I know a lot of people who like this business a lot, and I haven't done the work on it, so maybe I'm missing something, but to me it gets thrown in the "too hard" pile because of the housing bubble, which will no doubt damage all kinds of things that are close to the epicenter in all kinds of unforeseen ways.

[Potato]

I briefly looked into them almost two years ago (coming at it from the housing bear angle). The only conclusion I could reach was that they were run by wizards.

 

• They grow like stink, but spend next to nothing on marketing/attracting business. This is going up against the big banks, which are not pussy-cats in Canada.
  
• They don't attract business by discounting rates/being the cheapest.
  
• They are in the non-prime sector, so people may come to them by default after being rejected by the banks. However, I haven't seen a metric from them on how many applicants they reject, and haven't heard anecdotes of them rejecting people (or seen message board posts about people complaining that they don't have a notice of assessment to show this nosy mortgage dude from Home Trust...). Plus, this is in an era of notoriously loose lending by the big banks (fog a mirror, get a mortgage! You're richer than you think!). Yet, their default rates in good times are as good as prime (but got 3X worse in 2009).
  

 

They post consistently amazing results, and don't have any of the compromises I expected would come with that kind of growth. If it's all fabricated, I'm not smart enough to tell -- it doesn't look like they're just rolling the loans before they go bad. I have concerns about the housing market, and this looks like the natural short choice, but I just can't figure out what makes it tick.

[benhacker]

I shorted a small amount of this at year end.  I am a bit nervous though along the lines of Potato's thoughts.  While Ontario (HCG's main Province) doesn't have a ton of direct oil exposure, I figured a non-prime lender trading at 2.25+x TBV wouldn't see real strong stock price in the face of a continued oil slide given that it does business in what is widely considered a petro currency country.  I also believe the knock on effects of oil will affect non-oil Canada as well (although perhaps currency effects will help Ontario more for export, etc...)

 

That said, although I'm doing well on my short, I still kind of scratch my head about HCG's special sauce.  Other names in Canada are likely more directly exposed to oil + china weakness than HCG, without the risk of being Phil Fisher type businesses (CWB, and FN come to mind).

 

I'm I'm debating what to do.  We all have different styles, but to me, HCG historical financial performance isn't that meaningful to me as I can't explain it.  Their book seems appropriately stated, so I don't really get how this business makes the ROE it does without something dark lurking.  As a short I'm basically making an event bet + a bet that even if a secret badness isn't lurking, their ROE shouldn't be able to hold steady as they grow.

 

In all likelihood though, I'll close my short out here sometime and move on to something else... at that point HCG will promptly collapse to 1x TBV after I exit. ;-)

 

If someone knows why HCG can make such phenomenal returns in a commodity industry, I'd love to hear it!

[biaggio]

I shorted a small amount of this at year end.  I am a bit nervous though along the lines of Potato's thoughts.  While Ontario (HCG's main Province) doesn't have a ton of direct oil exposure, I figured a non-prime lender trading at 2.25+x TBV wouldn't see real strong stock price in the face of a continued oil slide given that it does business in what is widely considered a petro currency country.  I also believe the knock on effects of oil will affect non-oil Canada as well (although perhaps currency effects will help Ontario more for export, etc...)

 

That said, although I'm doing well on my short, I still kind of scratch my head about HCG's special sauce.  Other names in Canada are likely more directly exposed to oil + china weakness than HCG, without the risk of being Phil Fisher type businesses (CWB, and FN come to mind).

 

I'm I'm debating what to do.  We all have different styles, but to me, HCG historical financial performance isn't that meaningful to me as I can't explain it.  Their book seems appropriately stated, so I don't really get how this business makes the ROE it does without something dark lurking.  As a short I'm basically making an event bet + a bet that even if a secret badness isn't lurking, their ROE shouldn't be able to hold steady as they grow.

 

In all likelihood though, I'll close my short out here sometime and move on to something else... at that point HCG will promptly collapse to 1x TBV after I exit. ;-)

 

If someone knows why HCG can make such phenomenal returns in a commodity industry, I'd love to hear it!

 

I am no expert. Used to own it.

 

Your short has worked out for you so far.

 

I thought these guys loaned money to folks like Ericopoly. High asset, net worth, but poor income (or there is something else wrong with their application, but they have lots of collateral) so none of the usual banks will loan to them. As a result they can charge an extra 1-2% + leverage=ROE >20%.

 

From what I gather this is a very favourite short idea for US investors over the years but it has not worked out for them in the past. Maybe it will this time.

 

Its still highly regard by respected investors like Jason Doneville at Doneville Kent for the cloners out there. I was thinking of starting a position. That said, Ben I think you continue to do well in your short position.

[benhacker]

From what I gather this is a very favourite short idea for US investors over the years but it has not worked out for them in the past. Maybe it will this time.

 

Yes, it's kind of obvious (in a non-intelligent way).  It's one of the larger cap non-protected Canadian financial firms that comes on a screen.  It's been highlighted by Eisman who (rightly) has a good following (although his fund closed again... long OCN / short CA RE in 2013... ouch).  High multiple to book, all judgements of value based on historical financials + low TTM / forward PE.

 

My main reason to jump into the fray recently is just the catalyst that crude is down in CAD huge, and the knock on effects of this I believe are almost always misunderstood.  It's uncomfortable for guys like me to short on the downswing, but in this case I think there is another easy 10-20% to be made here.... and if oil snaps back to $60 tomorrow, I don't think HCG jumps too much.

 

Its still highly regard by respected investors like Jason Doneville at Doneville Kent for the cloners out there. I was thinking of starting a position. That said, Ben I think you continue to do well in your short position.

 

Yeah, I can't really provide a super intelligent summary of why these smart guys are wrong... I only have this feeling that HCG has the classic attributes** of a company that rips value investors faces off (probably rips the face off of shorts too! ;-) )... and in the last month, I recall seeing HCG pitched as a long for the first time in circles I run in... so I guess I just couldn't hold back anymore. ;-)

 

**

1) Finance (commodity) company with leverage

2) Lowish PE on the surface

3) History of strong financial performance

4) Winds which drove performance (Canada RE and commodity boom) and folks are already talking like it doesn't matter

 

These kinds of situations are odd, if HCG does another two years of >15% ROE, I'm wrong (book builds, valuation probably holds up), but if ROE goes to 12%, income growth falls to negative %, and all of a sudden investors start valuing on book, not on EPS, and the stock is down 50% in short order.  I think sheer risk aversion will actually take HCG down prior to any financial revelation of slowing / negative EPS trends.

 

We'll see.  Low conviction, mostly I wanted a direct hedge as I think China has fallen out of bed, and no one is really acting on the knowledge even if they believe it as well.

 

</macro off>

[KCLarkin]

all of a sudden investors start valuing on book

 

Have Canadian banks ever been valued based on book? Valuing banks based on book is a deep value quirk.

http://video.cnbc.com/gallery/?video=3000151816

 

By the way, here is the current score for Eisman's long OCN / short HCG since May 8, 2013:

-78.62% vs +44.53%

 

 

[benhacker]

Have Canadian banks ever been valued based on book? Valuing banks based on book is a deep value quirk.

http://video.cnbc.com/gallery/?video=3000151816

 

?

 

I don't know why a valuation methodology would be specific to Canada or not, but I would say valuation methods are most certainly always (almost) based on earnings / cash flows.  I guess my point being is that some business over earn in certain years (sometimes for many years) and investors forget that tangible assets (for the most part) are what generate real profits.  Sometimes a large divergence (again, for certain businesses) between market value and book is a sign that it will be profitable for new competition to enter the market, or the economic / asset characteristics of a business are temporarily and unusually good (and will decline).  Buffett is most certainly right that banks should be valued long term on their earnings... I own WFC and many financials that have at times (or now) trade(d) above book.

 

But regulated, large, TBTF, banks trading at large premiums to book is a separate issue from companies like HCG trading at large premiums to book.

 

Regardless, my comment was not about how HCG *should* be valued if earnings decline... my comment was only how I think it *will* be valued if earnings decline.  We shall see I guess.

 

By the way, here is the current score for Eisman's long OCN / short HCG since May 8, 2013:

-78.62% vs +44.53%

 

Yes, not a wonderful call. 

[KCLarkin]

"Home Capital Group - 50% Downside?" - Seeking Alpha

http://en.wikipedia.org/wiki/Truthiness

Home_Capital_Group_-_50%_Downside__-_Home_Capital_Group_Inc.pdf

[ItsAValueTrap]

To me, whether or not they should trade at a premium to book value depends on whether or not they are underwriting intelligently.

 

Unfortunately, I could not figure it out.  They provide very little information on their risk management, e.g. what portion of their insured mortgages is Genworth and what portion insured by the government.  I believe privately insured mortgages only protect 90% of the principal instead of 100%.

 

Their investor presentation is troubling.  They simply state that Canada is not in a housing bubble.  That's not prudent risk management in my opinion.  If there is a very small chance that Canadian RE is in a housing bubble, then assuming that the chance is 0% might get the company into a lot of trouble.

 

The company has done some smart things (e.g. the credit card stuff looks like it has low risk).  However, they aren't very transparent IMO.  The figures that they provide are wonky.  They claim that their loan book is safe because of high LTVs.  LTVs are high due to extrinsic factors- rising real estate prices.  The company doesn't seem to provide LTV stats for the LTV at the date of origination.

[Guest wellmont]

a certain northern california egg farmer is not fond of this company At All.

[peter1234]

a certain northern california egg farmer is not fond of this company At All.

 

Are you referring to this?

;)

 

Marc Cohodes @AlderLaneeggs  ·  Jan 9

Interesting on a Friday night what HCG comes with; Home Capital Appoints New Chief Risk Officer. Why? I thought there was no risk there

[KCLarkin]

CFO and CRO have been replaced in the last few months. A bit concerning.

[KCLarkin]

The company doesn't seem to provide LTV stats for the LTV at the date of origination.

 

From their 2009 annual report:

As at December 31, 2009 the average loan-to-value ratio at origination in the Company’s residential

loan portfolio was 68.8%

 

Legally, the maximum LTV at origination for a trust company is 80%. I think you can safely assume that most of their mortgages are traditional 20% down, 30 year amortization mortgages. Documentation and credit scores will be weaker than prime.

 

On the last call, they said they are doing more mortgages with 35% down. They seemed to suggest this was a new government standard for no-doc loans but I haven't been able to find any proof. Lower ratio loans have lower net income margins.

[ItsAValueTrap]

From their 2009 annual report:

As at December 31, 2009 the average loan-to-value ratio at origination in the Company’s residential

loan portfolio was 68.8%

 

Ah... I did not read that far back.

 

Legally, the maximum LTV at origination for a trust company is 80%.

I think they have a business line where they do LTV of 90%.  It has to be insured by the CMHC or a private insurer (in HCG's case it would be Genworth).

 

 

[biaggio]

http://www.bnn.ca/Video/player.aspx?vid=536379

 

Home Capital's outlook after BoC Rate decision

 

 

[KCLarkin]

Thanks for the video. Please share if you find anymore.

[benhacker]

For those interested:

 

http://finance.yahoo.com/news/home-capital-provides-q2-origination-211900969.html

 

I closed my (short) position for a solid profit in low $40's... but apparently should have held on.

[KCLarkin]

The traditional originations are the important number to watch. These "only" fell 15% year over year. But, there is enough circumstantial evidence to cause longs some sleepless nights.

 

Still, there are some pretty famous US shorts who either don't understand the company or are being dishonest (I suspect dishonest). Why does Marc Cohodes think that a drop in originations is the same as a drop in revenue? The company earns the bulk of its revenue from interest on existing loans not auctioning off new originations.

 

I closed most of my (long) position in February. Should be a fun battleground stock but still not cheap enough to get me excited.

[benhacker]

KC,

 

These "only" fell 15% year over year. But, there is enough circumstantial evidence to cause longs some sleepless nights.  --> agree

 

Still, there are some pretty famous US shorts who either don't understand the company or are being dishonest (I suspect dishonest). Why does Marc Cohodes think that a drop in originations is the same as a drop in revenue? The company earns the bulk of its revenue from interest on existing loans not auctioning off new originations.

 

--> Agree^2.  It's always the case, but especially so in controversial names, to make sure you know what you think the drivers are for the business, and also what you should or shouldn't care about. These battleground names just drudge up a lot of commentary by folks with... complex... motives.

 

Glad we both made money here even though we disagreed.

[KCLarkin]

I sold my last few shares today. I was hoping to unload into a dead cat bounce but I have no interest in owning the company when a director resigns two days before earnings:

 

http://www.newswire.ca/en/story/1576133/home-capital-group-inc-announces-director-resignation

 

I made a small profit on this but would have made a very large profit if I had traded more aggressively.

[LesPaul]

I had heard that the drop in origination was due to a number of sketchy brokers being cut off from HCG's funding...perhaps as a way for them to further legitimize HCG (the B lender stigma may never go away) & avoid worse consequences in the future?

 

I'm also not that worried about the resignation - if it was Soloway resigning I'd be very worried.

 

Full Disclosure: Own no shares but I think there might be a real opportunity here. Maybe not!

 

Edit: I'm not good at sentence structure!

[KCLarkin]

The resignation isn't the problem. The timing of the resignation is. There is either severe (understandable) tension on the board. Or the director is trying to cover his ass. It's a coin flip. Given the very crowded short trade, this will likely pop at some point. But I can also see it dropping below book. Too hard for me...