HCG.to - Home Capital Group

[Liberty]

I wrote up my thoughts in greater detail on my blog.

 

https://onbeyondinvesting.com/blogs/blog/home-capital-wtf-just-happened

 

Still so much to consider here.  Interested to hear what anyone thinks.

 

Just read it. Interesting take, thanks.

 

Edit: btw, Marc Cohodes complimented you:

 

[doughishere]

I wrote up my thoughts in greater detail on my blog.

 

https://onbeyondinvesting.com/blogs/blog/home-capital-wtf-just-happened

 

Still so much to consider here.  Interested to hear what anyone thinks.

 

I dont have a dog in the fight, shorting seems too difficult(costly?) and the scuttlebutt makes it hard to go long. So I dont know much but....these "elevated" housing prices are they due to all subprime buyers or are they chinese(dont even have to be) buyers who may not be the best quality but can make the payments.....If i remember correctly wasnt a lot of the pain due to interest rates "resetting" after a period of say 5 years(ARMs)........I mean everyone wants to find the next "big short" but does the exact same situation apply?

 

 

 

I guess what im asking is are the customers that HCG serve....are they the stripper that owns 5 condos subprime all with ARMs or more legitimate chinese(again, dont even have to be chinese) buyers who can make the payments. I mean employmeent is basically at full capacity in the states so is the same true for canada? Are the buyers already "defaulting" on the loans?

 

 

Edit: I also understand, from your article that theres fraud involved....but is 1/5 enough to stop the party? Is 1/5 legit estimate(keep in mind i know nothing)?  Also, from Ameera's piece...wouldn't tighter lending just force the lowest(crappiest) buyers out possibly reducing volume more than "ability to pay"?

 

 

Dont you need to wait until theres forced sellers for the market to start to capitulate...ie. anyone who over paid for their house to loose their job or what not?

 

Apologies in advance for dumb questions.

 

 

Edit2: I dont mean this in a d*ckish way, but have you considered that you're(and its not just you) just wrong? There has to be some sort of possibility that you haven't reached the point of no return yet? Even you say that you "feel...that the housing market was beginning to crack." What happens tipping point just isnt there yet?

 

Edit3: One final comment I swear. You mention that you have a guesstimate book value of ~17.85 and the stock price is basically right there....so why not get out? Whats the real likelihood of HCGs reserves going to 3% instead of the .13%? And if youre absolutely sure about HCG going to the 3% target....how long could/will it take to get there?

 

The reserves from buffett seem to me to be a form of "off the balance sheet" reserves that they pay 1% on while they attempt to clean up the business and keep their current reserves at .13%. Im not completely sold on this little idea of mine yet but it seems reasonable at the moment. At minium....it kicks the can down the road and will cost you(and marc) more to carry it though "to the end of the earth."

 

Whats the one thing that would guarantee that this goes bust no-matter what? Even if uncle warren or the Canadian govt steps in....and when is that?

 

 

Edit4: It also seems that your thesis is broken. (or what I assumed your thisis before the deal was absolute bankruptcy) that "This deal immediately takes bankruptcy off the table for HCG,"  Not my words. Yours. And again im not trying to be d*ckish...just point out something you already know.

[TBW]

Good questions.  First answer, I largely did cover my short except for some very OTM and ITM puts.  You are correct this deal certainly does prolong HCG, and with the borrow being so expensive it is prohibitive.

 

The market up here has been an asset bubble, imo.  What I mean by that is assets rise, that rise allows more money to be borrowed to buy more assets, asset prices rise further, repeat.  With people getting caught up in the mania I lead to some fraud to get involved.  With banks being 10 to 20x levered it doesn't take much in the way of defaults for this to get really ugly for the banks.  There is also risk coming in from HELOCs, unsecured lines, credit cards etc.

 

The only way HCG goes down now is if/when housing prices drop significantly.  If that doesn't happen, with the extra liquidity they are fine. Could I be wrong on timing, absolutely.

 

There are better housing related shorts now in Canada than HCG and I have been adding to those.

[clutch]

Just to give you an anecdotal story...

 

Over the weekend, I drove around different parts of Toronto, mainly in nice neighborhoods where I'd like to make a permanent home one day. While doing so, I noticed a large number of "For Sale" signs in front of houses. I took this as a sign that many people are trying to take profits before the market cools down further. But is this a sign of a forthcoming crash?

 

In particular, in the North York area, there were about 3-4 For Sale signs within a single block. These were very good houses (not the crummy old houses seen at some of the Twitter posts mocking the situation) and a good neighborhood. I checked online for asking prices and they were typically 2-3 mil.

 

At least for a couple of these houses I felt like nobody lived there. I suspected that these were bought by "flippers", perhaps foreign investors, with the intention of selling them soon - in some cases without even bothering to rent them.

 

There were of course houses that people were clearly living in, who I suspect are upper middle class families who bought these houses years ago and trying to take profits.

 

The point of this story is that I'm not sure for either of these cases the owners would be forced to sell at a fire sale price because of default, or even the anticipation of a crash.

 

Maybe there are "local" investors who leveraged up to their throat to buy as many multiple properties as they could. They would be more exposed to default. But I don't know many of such people around me. I have one friend who could be considered as such, but all of his properties break even (according to him) in terms of monthly cash flows, and he has no problem finding tenants. I.E., he could be in trouble only if there is a significant rise in the interest rate or there is a sudden oversupply of housing / people fleeing Toronto. Neither seems very likely at the moment.

 

Take my story with a grain of salt, but the only way we would get a significant crash is if the foreign investors suddenly had to sell their investments for whatever unforeseeable reasons. But think about this - when would they ever sell their investments at a loss if they didn't HAVE TO? Wouldn't they just ride out the market and be happy to keep their houses and collect rents? Personally, I wouldn't be able to find any more "safe" investment (in terms of permanent loss of capital over long-term) than a property in Toronto.

 

Then there are people like me and many of young professionals around my age (mid-30), who want to call Toronto our permanent homes and are eagerly looking for places to buy at reasonable prices. So IMO there will be a plenty of people to create a "support level" when there is a crash.

 

So to me "cooling" would be a more likely scenario than a "crash".

 

[biaggio]

I was shocked that BRK involved in this.

 

Everybody talks about crappy underwriting. Does anyone have any evidence of crappy underwriting? I know that its written all over twitter etc (I have been getting an education) but where is the actual documentation

 

The company has been under intensive scrutiny by OFSI, OSC,perhaps CMHC etc according to the folks negative on the company and yet there is no announcements or reports from these government agencies that the delinquincies are false and that the reserves need to be higher. I am confused (as usual). Is the gov't allow going to perpetuate a fraud, maybe to try rip off WEB

 

Why would the new seasoned successful financial guys on the board (and even Solloway) even be involved in obvious fraudulent operation? They are not doing it for the money they are all rich already. Why would they risk their reputation?

 

Is there any chance that we are all wrong re underwriting, reserves etc and the folks at BRK know what they are doing. If I was WEB there is no way I would get involved in such as small deal with limited upside, size wise, if there was any chance it would go to zero. That would be embarrassing in my opinion.

 

I believe there is real value in the collateral ---I think if a HCG client defaulted on their mortgage payment in UCCAL's or Sharper's neighbourhood--I am sure they would be interested in buying at 60 cents on the dollar (LTV is 60% on their uninsured portfolio)

 

This might be the opposite of the Valient investment in that you have all these famous hedge funds shorting, all kinds of negative hype etc who are wrong on this company, like ACkman etc were wrong on VFX. The big difference is the type of assets involved being sold-- mostly I admit overpriced Toronto residential homes vs overpriced crappy drugs

 

In regards to the security fraud--Old management did screw up---their controls were not perfect---I understand even big banks get burned from time to time--but its not like that tried to cover it up--they reported it immediately to OFSi and CMHC, and they sought outside counsel on whether it should be publicly disclosed. Its my understanding that they made a judgement that it was not material and were advised by outside law firm that they did not have to disclose. In my obviously they were worried about what the shorts would do with the info...we know what happens later, LOL... then they fire their CEO and I don't know what they were thinking here and maybe there is something sinister here...there were certainly a lot of mistakes from top management and board--but they have all been replaced. I think they settled with OSC, including the class action suit (though both have to be approved a bit later) for virtually nothing but had to admit wrong doing which hurts but they had little choice as they had lost public confidence and probably would not be able to cut deal with WEB otherwise

 

re the bad HOOP loan--it will be paid off by mortgages coming due in the next 6 weeks and there is the expectation that they will not need to use BRK's loan--just pay the stand by fee of 1%. The BRK backstop and common investment is expected to fix their deposit problem--you can follow the progress daily as they have an announcement daily on there liquidity.

 

Fully diluted I agree with the noted blog above of tangible BV of $17

 

Why can't it sell for 2 x BV in 3 years. Even if housing market crashes with prices dropping 40% (which it means we could have bigger problems) they could still be ok

 

It may earn 7% ROE this year but I think they could earn 15% ROE next year. My understanding that their clients will pay higher interest rates as there is often not a lot of alternative lenders.

 

I am surprised that smart guys on this board are not more positive with all the new developments and an opportunity to participate in a WEB sponsored company.

 

HCG may not be a platform to take over CIBC (LOL) as written in the blog above, but with BRK money, HCG  might be a more aggressive competitor for the big Canadian banks---maybe thats what the govt wants as it would be good for the consumer.

 

Full disclosure--I owned this POS (small position)  before the whole debacle/run on deposits and really wanted to sell out of my positon but it was fairly small position and I decided to do the opposite of what my intuition was telling me to see what would happen. I doubled up on the shares when the dividend was eliminated. This was easier to do with a <5% position...

 

I would have never guessed that BRK would be involved.

 

Cohodes is a smart guy I am sure/smarter then me for sure, I have learned a whole lot from listening to his interviews

 

Have been wrong on this one. Have been wrong a lot. Story/thesis is different it seems. I am surprised that folks here are not changing their opinions as the facts seem to have changed.

[KCLarkin]

Does anyone have any evidence of crappy underwriting?

 

They intentionally skirted the CMHC rules by offering 90-100% LTV by bundling compliant mortgages (>20% down) with 2nd mortgages offered by a MIC run by Solloway's daughter. It's true that the 2nd mortgages will bear the initial losses, but these practices add systematic risk. When the MICs disappear, there will be nobody to fund the down payments. Valuations will have an air pocket. And what looks like prudent underwriting, could look foolish.

 

The practice of phantom ticking and no separation between sales and underwriting, also indicate that HCG's claims of prudent underwriting are overstated.

 

I don't think you'll see 9% default rates like you see in U.S. subprime though.

 

There is also a question of whether they are hiding defaults (like Allied Capital did) by transferring them to Re-Charge or other entities.

[biaggio]

Thanks KC

 

I am very mindful of my increasing bias and rationalization

 

re bundling

http://www.cbc.ca/news/business/mortgage-lenders-bundled-debt-1.3930774

 

According to this article its common practice except big 6 don't do it but it is not illegal. OFSI etc aware. These loans are not insured by CMHC

 

also found this article

http://business.financialpost.com/commodities/energy/exclusive-canadas-financial-watchdog-warns-lenders-against-bundled-loans/wcm/6b5a6093-a795-425b-98a6-326816a3a077

which expresses regulators more concern for the practice.

 

Thus far delinquencies are low but can change instantly and dramatically when the tide goes out, especially if they are doing stupid stuff

 

Agree that dealing with company owned by CEO's daughter seems shady.

 

I am aware of Recharge---> I thought it was a smart move selling "work outs", potentially non performing loans to non related company/lawfirm.

 

For those not familiar here is a summary of Allied Capital

https://www.fool.com/investing/general/2015/03/26/allied-capital-5-years-after-its-downfall.aspx

 

Its seems unlikely (but possible) that company is hiding stuff  with all the various regulators having gone thru there books, loans etc repeatedly over the last 2 years

 

Here is the company's version

http://www.newswire.ca/news-releases/home-capital-statement-on-relationship-with-brookstreet-mic-inc-596083121.html

 

No doubt this idea has fleas on it and hence the low valuation. Certainly a non consensus idea.

 

This sucker should promptly go down 50% now that I have written the last 2 posts.

 

[Libs]

Much is being made of HCG's 60% LTV on uninsured mortgages. However, I understand they have high loan turnover - about a third of the book annually - and 'low retention'.

 

That being the case, if they are replacing that maturing 60% LTV, 420K loan on a 700K property with a new, (20% down) 560K loan on an identical 700K property, they've lost half their cushion. They've gone from 60% to 80%.

 

Am I thinking about this right? Has this been a problem in the past?

[rb]

Much is being made of HCG's 60% LTV on uninsured mortgages. However, I understand they have high loan turnover - about a third of the book annually - and 'low retention'.

 

That being the case, if they are replacing that maturing 60% LTV, 420K loan on a 700K property with a new, (20% down) 560K loan on an identical 700K property, they've lost half their cushion. They've gone from 60% to 80%.

 

Am I thinking about this right? Has this been a problem in the past?

I don't think that you're thinking about it correctly. Firstly about turnover and retention. Since Canadian mortgages renew every 5 years, 1/3 of book turnover would not be something out of the ordinary in a declining interest rate environment for any FI here. The low retention probably has to do with the fact that HCG is all broker channel so it's a lot of bottom rate shopping. So again fairly standard for a business like HCG.

 

In my opinion this renewal probably doesn't hurt their cushion because they probably never had much of a cushion to start. I'm willing to bet that their LTV profile is bi-modal so they're mixing high LTVs with low LTVs to get a nice average the same way CDOs did with average credit scores. They'll continue to do that and you'll continue to see a nice average LTV number.

[TBW]

After reading this ZH article, where a short seller received a KPMG review of HCG after the mortgage fraud incidents, about how HCG is lending its really hard to think 7bps will cover their loan losses.  I knew their lending was bad but this is much worse than I even expected.  http://www.zerohedge.com/news/2017-08-02/exclusive-how-home-capital-sausages-were-made

 

It also inspired me to write this https://onbeyondinvesting.com/blogs/blog/long-versus-short-canadian-lenders-why-are-opinions-so-different about why view are so different on Canadian lenders.  It has to do with how investors take into account probabilities versus reported earnings of financials.

[rb]

After reading this ZH article, where a short seller received a KPMG review of HCG after the mortgage fraud incidents, about how HCG is lending its really hard to think 7bps will cover their loan losses.  I knew their lending was bad but this is much worse than I even expected.  http://www.zerohedge.com/news/2017-08-02/exclusive-how-home-capital-sausages-were-made

 

It also inspired me to write this https://onbeyondinvesting.com/blogs/blog/long-versus-short-canadian-lenders-why-are-opinions-so-different about why view are so different on Canadian lenders.  It has to do with how investors take into account probabilities versus reported earnings of financials.

I read the ZH article. Usually when i read one of those I have a boulder (not a grain) of salt nearby. However despite the "exclusivity" the article did not tell us much that we didn't know -- HCG was writing mortgages with their eyes closed, palms over their ears chanting lalalalala to the worst credits out there.

 

I also read your post. I disagree with it a bit. Basically the accounting stuff is GAAP and accounting does as accounting does. So yea, loss reserves are understated for every Canadian FI due to GAAP. But I also don't think that shareholders are ignoring this and the probabilistic aspect of it. With a couple of exceptions the P/B ratios for Canadian FIs are pretty subdued. This is a reflection of the probabilities. Where I think there's a disconnect in the market is that some investors equate the shit subprime players like EQB and MIC to the big banks. But then that's a case of mispriced securities and a story as old as the market itself.

[TBW]

Fair points RB.  I realize its accounting but there is never anything preventing reserves to be taken when management deems them necessary.  I have seen that before.  They can choose not to do anymore than the accounting calls for, but that is a conscious choice they make.

 

Bigger banks trade in the 1.6 to 2.2x book range.  Those value, in my opinion, are because of inflated ROE's due to lack of provisions.  So I don't think market is pricing in the probabilities as much.  Unless you want to say CWB at 1.2x in relative terms is showing some sign of this being priced in on a relative basis, then yes  I can see your point there.

 

As far as just plain old mispricings like MIC and EQB, you could be right.  But I also wonder if this lack of current losses breeds complacency that leads to such mispricings.  If banking earnings were more volatile, reflecting such loan losses, perhaps those mispricings wouldn't be as glaring as you and i see them.

[rb]

I was speaking more about the big banks. I could be wrong, but the top end is about 1.9 book for RY and CM. I think those are high, especially for CM.

 

TD and BNS are at 1.6, and BMO is at 1.36. These seem fair. I think that if we were to have happy days from here on out these names should be about 2x book and the lower multiples reflect what you call the inflated ROEs or understated loss provisions - which are essentially the same thing. I wouldn't say they're cheap but I can't say they're expensive either. (I don't consider CWB to be either large or quality)

 

Another thing that may contribute to mispricings could be the passive ETF/index fund that correlates the crap to the higher quality names.

[gg]

After reading this ZH article, where a short seller received a KPMG review of HCG after the mortgage fraud incidents, about how HCG is lending its really hard to think 7bps will cover their loan losses.  I knew their lending was bad but this is much worse than I even expected.  http://www.zerohedge.com/news/2017-08-02/exclusive-how-home-capital-sausages-were-made

 

It also inspired me to write this https://onbeyondinvesting.com/blogs/blog/long-versus-short-canadian-lenders-why-are-opinions-so-different about why view are so different on Canadian lenders.  It has to do with how investors take into account probabilities versus reported earnings of financials.

I read the ZH article. Usually when i read one of those I have a boulder (not a grain) of salt nearby. However despite the "exclusivity" the article did not tell us much that we didn't know -- HCG was writing mortgages with their eyes closed, palms over their ears chanting lalalalala to the worst credits out there.

 

I also read your post. I disagree with it a bit. Basically the accounting stuff is GAAP and accounting does as accounting does. So yea, loss reserves are understated for every Canadian FI due to GAAP. But I also don't think that shareholders are ignoring this and the probabilistic aspect of it. With a couple of exceptions the P/B ratios for Canadian FIs are pretty subdued. This is a reflection of the probabilities. Where I think there's a disconnect in the market is that some investors equate the shit subprime players like EQB and MIC to the big banks. But then that's a case of mispriced securities and a story as old as the market itself.

 

Are you suggesting the accounting versus valuation is OK because all the financial firms are overstating gaap, and therefore the market valuations take that into consideration already?

 

My understand of the HCG story is that they are not really reporting the actual numbers per gaap. Instead of having a line item that shows significant loan losses (which would maybe be indicative that they have a business model issue), they are alleged to be fraudulently running those loan losses through an overhead line item. So the issue really boils down to whether loan losses will be consistent, or if they have a business model issue and will eventually face a significant amount of loan losses to the point that there is no business value left.

[Liberty]

https://www.theglobeandmail.com/report-on-business/home-capital-managers-ignored-warnings-from-regulators-industry-partners-report/article35896961/

[FiveSigma]

KPMG report:

 

http://hcgexposed.com/wp-content/uploads/2017/08/HCG-internal-fraud-report-KPMG.pdf

 

Pretty damning.

 

[Liberty]

http://www.cbc.ca/news/business/osc-home-capital-settlement-1.4240185

 

Ontario's securities regulator has approved a settlement deal with Home Capital Group Inc. and several former company executives in the wake of the disclosure scandal that rocked the alternative lender.

 

An Ontario Securities Commission panel gave the nod to the settlement at a hearing Wednesday morning in Toronto.

 

The agreement, which was reached in mid-June, sees Home Capital Group pay $10 million to settle with the OSC and reimburse the watchdog costs of $500,000.

 

In addition, Home Capital founder Gerald Soloway was hit with pay an administrative penalty of $1 million. He is barred from acting as a director or officer of a public company for four years.

[Liberty]

Marc Cohodes now going after Turtle Creek:

 

http://upturtlecreekwithoutapaddle.com

[KCLarkin]

Marc Cohodes now going after Turtle Creek:

 

http://upturtlecreekwithoutapaddle.com

 

Given the hype, this is pretty weak. He's basically accusing them of cherry-picking funds and benchmarks to put their performance in the best possible light.

 

Then he does the same thing. To put their performance in the worst possible light, he cherrypicks the period from Jan 2010-July 2017. Notably, this period includes the HCG meltdown. And excludes 2009. A year, when TC claims that they returned ~147%. And a period of high volatility for CAD.

 

--

Benchmarking Canadian funds is really difficult. The TSX is a horrible benchmark because it overweights resources and financials. But the S&P 500 isn't a great benchmark for this fund either, since TC mostly invests in small and mid-caps. Plus, the last 10 years included remarkable volatility in USDCAD. Turtle Creek seems to be inconsistent with their benchmark. But they usually mention the returns versus both SP500 (CAD) and TSX But I think the TSX is really the best benchmark. This best represents the equity performance that their Canadian investors would receive if not invested in TC.

 

[thowed]

I have the utmost respect for Turtle Creek.  However I also try to keep an open mind about everything, so I can't deny that I'm fascinated to see how this turns out.

 

I don't really see what his incentive is for going after them, beyond them being on the other side of HCG.

 

And agreed that the whole benchmark thing is confusing.

[Peregrine]

Marc Cohodes now going after Turtle Creek:

 

http://upturtlecreekwithoutapaddle.com

 

What a nutjob.

 

Quite incredible that someone with as horrid a track record and reputation as his gets the kind of attention that he gets.

[Liberty]

http://www.homecapital.com/presentations/investor2017/Q3%202017%20Investor%20Slides.pdf

 

Net income fell over 50% year-on-year in Q3... Mortgage origination dropped 85%.

[SharperDingaan]

http://www.homecapital.com/presentations/investor2017/Q3%202017%20Investor%20Slides.pdf

 

Net income fell over 50% year-on-year in Q3... Mortgage origination dropped 85%.

 

The numbers are just noise at this point; the reality is that they are distribution channel with name recognition - that isn't going to be going away anytime soon. The only real question is where their highest valuation will be over the next 2-3 years.

 

SD

 

[Liberty]

http://www.homecapital.com/presentations/investor2017/Q3%202017%20Investor%20Slides.pdf

 

Net income fell over 50% year-on-year in Q3... Mortgage origination dropped 85%.

 

The numbers are just noise at this point; the reality is that they are distribution channel with name recognition - that isn't going to be going away anytime soon. The only real question is where their highest valuation will be over the next 2-3 years.

 

SD

 

 

If net income was up 50% and origination up 85%, would you be calling it noise?

[SharperDingaan]

http://www.homecapital.com/presentations/investor2017/Q3%202017%20Investor%20Slides.pdf

 

Net income fell over 50% year-on-year in Q3... Mortgage origination dropped 85%.

 

The numbers are just noise at this point; the reality is that they are distribution channel with name recognition - that isn't going to be going away anytime soon. The only real question is where their highest valuation will be over the next 2-3 years.

 

SD

 

 

If net income was up 50% and origination up 85%, would you be calling it noise?

 

We deal in reality; were the numbers as you propose, we would be shorting the hell of it - as that could not have occurred without some material manipulation. The facts are they survived the raid, are stable, and are able to carry on their business; there was already an expectation of a material adverse change in the size of their business - we now know how adverse that change was.

 

SD