Home Capital's (HMCBF) CEO Gerald Soloway on Q4 2015 Results - Earnings Call Transcript

| About: Home Capital (HMCBF)

Home Capital Group Inc. (OTC:HMCBF) Q4 2015 Results Earnings Conference Call February 11, 2015 10:30 AM ET

Executives

Gerald Soloway - CEO

Robert Morton - EVP & CFO

Garry Willson - EVP, Underwriting

Pino Decina - EVP, Residential Mortgage Lending

Martin Reid - President

Analysts

Shubha Khan - National Bank Financial

Dylan Stewart - Industrial Alliance

Jordan Hymowitz - Philadelphia Financial

Graham Ryding - TD Securities

Stephen Boland - GMP Securities

Operator

Good morning. My name is Steve and I will be your conference operator today. At this time, I would like to welcome everyone to the Home Capital Group Fourth Quarter and Yearend Results Conference Call.

All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I'll now turn the conference over to Gerald Soloway, Chief Executive Officer. Please go ahead.

Gerald Soloway

Thank you, operator. Good morning Good morning, fellow shareholders, ladies and gentlemen. Thank you very much for joining us today to discuss our results for the fourth quarter and full year 2015, a year in which we made good progress in building our business in a prudent, profitable and sustainable manner.

2015 was a profitable year and one in which we further solidified our very strong balance sheet. We made progress on our deposit diversification strategy and we grew our lending business in promising areas outside our core mortgage business.

In short, we ended 2015 in very good shape, which enabled us to raise our dividend by 9.1% and also announced plans for $150 million common share buyback. I am pleased to highlight that even in the face of some challenges in 2015, our adjusted diluted earnings and adjusted diluted earnings per share were on par with the record levels of 2014.

Adjusted 2015 net income was $288.9 million, essentially flat compared to the previous year. Adjusted diluted earnings per share were $4.11 for 2015, the same as the $4.11 we reported the year before. So while we might have liked a bit more growth, we did maintain profit levels at the highest in our history.

For the fourth quarter, adjusted net income per share was $1.02. That was flat relative to the fourth quarter of 2014. Return on shareholder's equity on an adjusted basis was 18% for the fourth quarter and 18.8% for the year as a whole and book value per common share reached $23.17, demonstrating that we're building value for shareholders and our common equity Tier 1 capital ratio stood at 18.31%, which is very, very strong.

And Home yet again had an outstanding credit performance, with net non-performing loans of 0.28% of gross loans as of yearend, compared to 0.30% at the end of 2014.

Our net write-offs for 2015 as a percentage of gross uninsured loans were four basis points as low as I can recall. That's down from six basis points in 2014 and for the quarter net write-offs were five basis points down from seven basis points in the fourth quarter of 2014. So continuing very strong credit performance.

We also made progress in other important ways in 2015. Deposits with Oaken have now topped a $1 billion for the first time, demonstrating the success of our broker diversification efforts. I should point out that about two years ago before we started Oaken, approximately 2% of our deposits came from non-broker sources.

I am delighted to report that as of January 15, 26.9% of deposits now come from non-broker areas, not that we don't appreciate and love the deposit brokers, but we just be regarded as a safer long-term policy for the company to have wide diversification in its deposit source.

I think you will see continuous growth in Oaken share of the company's deposits, Oaken, which is a strategy of accessing deposits direct from the public, that percentage of total deposits in the company will continue to increase over time.

We also have made important strides in improving our mortgage origination platform as we roll out our new broker portal and partnership platform. We're working towards being able to give a four-hour turnaround to our broker network.

This will not be a commitment, but this will be an indication of where we're going on the deal. Whether it's something within our risk climate or risk parameters or not and we think that between the new portal program and other programs that are in place, we'll be rolling that out for the spring market.

We invested in low risk -- in lowering the risk and risk management, operations and technology, all part of what running and what is now running a very large business.

We announced three co-branded Visa products including one in the fourth quarter with Giant Tiger helping to further diversify our lending business. We'll continue to look at opportunities like these.

And finally late in the year we closed our purchase of a licensed bank, CFF Bank. This fulfilled the strategic priority we had been pursuing for some time.

The integration of CFF is going very well and we see the benefits from the additional distribution that CFF brings to us and we have seen that in the fourth quarter and so far this year.

We know that for many Canadians they like knowing me or dealing with a bank. Many do not know what a trust company is and we have found that having a bank is a very important part of our offering of our deposit raising efforts.

We also have the relationships with certain independently operated Canadian First Financial Centers CFF centers across Canada, which distribute CFF products including mortgages, deposits and personal banking products. And on the integration front, all of the employees that we’ve retained have been transitioned to Home Trust and we're now working hard on decommissioning on old redundant computer system.

All in all CFF is a great investment in the future of our business, the diversification of our deposit products and new sources of accessing mortgages and we're very, very pleased with the acquisition.

We shall continue to invest in our business to strengthen risk and compliance oversight further improve our customer service platforms, direct deposit and loan originations and at the same time we will always be looking for ways to manage cost and find efficiencies.

I think you'll find that in every regulated financial institution that’s reporting there has been an awareness and an increased attention to improving risk compliance and improving security of the computer system and there is a cost to that.

So we don’t apologize for that cost. We just say that that will make us a better and stronger company going forward and we just have to absorb it at this point to get us up to a level that we can be comfortable with.

And we recognized that the net result is that on the expense front we see our efficiency ratio remaining relatively high in 2016 with the levels we reported at the end of 2015.

We don’t see any quick fix there. We think we can hold them at the current level. We think as we grow the income and the asset base, they will shrink, but there is not going to be a dramatic dropping in that cost because there is cost for getting all of the varies items I mentioned up to high operating level.

And we recognize that this run rate is higher than historically been the case. However we honestly believe that these types of investments I mentioned earlier are important and necessary to set up Home Capital for future growth and this is the right time to make those investments.

Given the strength of our balance sheet, we are returning more capital to shareholders in two ways. One, we've announced an increase in our quarterly dividend of 9.1% of $0.02 a share to $0.24 per quarter or $0.96 annually. This is in recognition of the company’s solid financial position and growth prospectus.

Secondly, we're planning to do a $150 -- $150 million share buyback. We'll announce more details about that in due course as there are certain regulatory filings that we will do and complete an announce them to the public and this buyback could support earnings per share accretion somewhere in the 6.5% to 7.5% increase.

The buyback of course will be on top of our normal course issuer bid. As many of you have noted, we have been more active since renewing the normal course issuer bid in September than we have been in the year prior to that and we'll continue the bid on a going forward basis.

We expect the buyback activity will have a number of helpful effects. It will underpin earnings per share by shrinking our share count significantly. It will also reduce the amount of excess capital on our balance sheet, which helps to drive stronger returns on equity that of course is simple mathematics, but just as important, this return of capital demonstrates our continuing commitment to deliver value to our shareholders and to growing that value over time.

Looking ahead to 2016, we're optimistic about the outlook for our business. The Canadian economy is certainly experiencing the effects of change in commodity prices especially in Alberta. However, it’s worth remembering that Alberta accounts for only about 4% of our balance sheet portfolio and a portion of that 4% is insured mortgages.

Ontario, which remains the preponderance of our business, should see some benefits from a more positive outlook in the U.S. economy. The weaker Canadian dollar, lower interest rates and the benefits of lower oil prices on economic will we believe improve economic growth in Central Canada.

So our view is that the housing market in 2016 will be balanced with relatively stable prices and sales volumes, although of course we accept that there will be regional disparities and against that backdrop, we will be working very hard to increase our market share of the market that we participate in.

We fully expect to see an increasing origination volume in 2016 over what we experienced last year. You saw progress on that increasing volume in the fourth quarter and that has continued into the early period of 2016.

In addition, outside the core residential business, we're continuing to grow other aspects of our business. I mentioned the Visa products, which we're very optimistic about. On our other lending category, which includes our Visa products, we find that that is a very profitable segment relative to its size and what's more this category is growing.

These assets represent 3.7% of our on balance sheet loan portfolio, but generate 7% of the interest income from loans for the fourth quarter. So we like those yields and we'll do everything we can to keep growing those businesses in a prudent and safe manner.

I would also point out that our other lending quote unquote “business”, which is the retail credit group is showing this growth even after we had a payout of a large water heater portfolio at the end of 2014.

This was an item in the 2014 profit something over $32.5 million pretax and was launched on the -- was on the statement for 2014 and had we not been paid out of that portfolio and we were paid all the interest differential to maturity, if that would have continued this past year, it would have added in 2015 about 12.6% of net interest income for us, which we got the year before, which is equal to about 9.3% after tax or above 13% per share.

So as one of things to think about we did have a little bit of an increase this year but we in the overall company and earnings per share, but that came in last year.

Similarly we like the diversification in yield we got with our commercial business, which grew at a strong rate in 2015. For example in a non-residential commercial category, originations nearly doubled to $755 million last year.

We operate this commercial portfolio in a very safe and sound basis on low loan to value large portion, small storing apartments, small commercial building or if there are other than small buildings, we insist on very strong sponsorship and strong income streams.

Similarly, we like the diversification in yield we get with our commercial business and as I said earlier, and we will continue to grow it in a careful way in the year ahead.

And we’re quite comfortable growing that portfolio in 2016 assuming and I’d say this, assuming market conditions continue to remain favorable. So the sum it up, we're looking for a very solid 2016. We think we will have a very good year this year.

And with that, I’d like to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Shubha Khan from National Bank Financial. Your line is open.

Shubha Khan

Thanks. Good morning.

Gerald Soloway

Good morning, Shubha.

Shubha Khan

You mentioned in you MD&A that you expect recent changes to mortgage lending regulations to increase demand for at least a single family traditional mortgage product.

Specifically which regulations are you expecting to expand your addressable market and how much of an impact to your margin it might have relative to say the impact that B20 had on increasing your addressable market?

Gerald Soloway

Well, I don’t know if we've done any work on quantifying it, because on the insured part what has come about is the margins are still very tight on the insured part and I think that what you'll see is you'll see a steady increase in what we're doing both from our core business.

I think what happens is that it becomes a little more complicated, the processes are little more complicated and more loans get bounced out of the system. We're a little more vigorous in our underwriting. There is not much ability to vary from what the recruitments are with CMHC. So we see a steady business there.

But notwithstanding B20 and it had changes, it also excluded people who might have gone to the banks and they got bounced out of there and we just see that the key for us is to be very competitive in our space to have the better technology, to give the brokers a fast turnaround and we think we can see some nice increases in all aspects of our business with technology, but I’m not really able, I am sure Martin has some comments as well.

Martin Reid

Hi Shubha, the recent changes in particular around insurance will have a bid of an impact in terms of pushing more people into that uninsured, but it’s relatively small. It’s nothing like the impact that B20 had on the marketplace. So, I wouldn’t build the whole lot into that.

Shubha Khan

Got it. Okay. And then as far as the buyback is concerned, I know that the terms and conditions still have to be finalized, but wondering whether you can give us any preliminary color on timing?

And also the way I understand it, the buyback is for up to $150 million. So just wondering what conditions would call for let's say a smaller buyback? Does it just depend on or is it entirely dependent on the stock price where it's trading or are there other variables that would affect your decision?

Gerald Soloway

Shubha, I think you're going to understand my answer. This is a highly regulated area. We already declared we've retained Royal Bank. We retained our law firm inventories. We’re going to move ahead on that immediately. There is going to be no delay, but there has got to be a regulatory filing, which sets all this out.

It will all be made public and quite frankly I’m afraid to say anything now I don’t want to do anything that would get us in any trouble on the regulatory filings before we file.

So you would appreciate, we’ve got clearance to make the announcement. We've said what we can say and I can say to you we will get that filings done as quickly as we can do the legal and another step, which should be in a matter of week. It's not a matter of waiting six months.

Martin Reid

And Shubha, our intent is to utilize the full $150 million. So I can't think of any circumstances where we wouldn’t unless people don’t tender their shares but our intent is to utilize the full $150 million and as Gerry mentioned, this is in addition to the normal course issuer bid where we have increased our activity and will continue increasing our activity.

Shubha Khan

Okay. That’s perfect. And finally just on expenses, I think you mentioned that you incurred $1.6 million in the quarter related to what you call realignment of business relationships in the quarter. Does this specifically relate to your new broker partnership program and do you expect this particular expense to moderate and if so over what timeframe?

Gerald Soloway

I am going to turn this over to Rob Morton, our Chief Financial Officer. He'll answer that.

Robert Morton

And so thanks for the question and yes, part of that is. So if credit spreads on a lot of things. Some of it is the investment we’ve made in technology performance and other areas its professional fees too that we've incurred.

And I think you’re going to see that our efficiency ratio is going to remain high for the next few quarters. Some of that's going to be our acquisition of CFF as well. So we’re continuing really to invest in the business and to prepare ourselves for what we hope is going to be long-term growth.

Shubha Khan

So suffice it to say you’re looking to invest at this rate in your broker relationships through 2016 and maybe any moderation will come through over the next year is that a fair summary?

Robert Morton

I believe at least through I would say the first half of 2016 where we're going to be running at this rate I would think. And like I said we've got probably about right now about $0.03 drag with CFF and just we fully integrate it. So that's something to consider as well.

Shubha Khan

Got it, perfect. Thanks.

Operator

Your next question comes from the line of Dylan Stewart with Industrial Alliance Securities. Your line is now open.

Dylan Stewart

Good morning, guys.

Gerald Soloway

Good morning, Dylan.

Dylan Stewart

A quick question. You mentioned on the call just on the commercial mortgage book, you mentioned that was below loan to value, can you just remind me what the average loan to value is on those loans?

Gerald Soloway

We're just looking that up, but I think it's well under 70, but is there another question and I will come back to that.

Dylan Stewart

Yes just on the uninsured mortgages, looks like the run-off of the book, you talk a lot about the origination, but the run-off seems to be a bit higher than normal, last couple of quarters. Is that tied to the run off of the suspended broker portion of that or is there anything else going on there?

Gerald Soloway

No I don’t think there is anything else. So as we made it clear that the way we've done the review of the portfolio, when we look at the files that are closest to maturity and we make sure that before we renew any files, we get all the documentation.

Now the way it's running, there is about 90% of the renewals that are coming up, we can get all the documentation and everything is fine and we're happy to renew the mortgage.

There is a small portion where we need increased documentation. Sometimes we go back to the broker and we’ll go back and even though we're not doing business with this broker, we'll tell them that it's their client that we need some documentation and we can’t renew it.

Sometimes we’ve seen cases rather than give us the documentation the broker is a little unhappy about being cut off and he will just transfer mortgage to another source.

But we're not concerned because there are other sources that will take less documentation. They may be privates. They may be some of the credit unions. They may be other financial institutions.

So, I don’t think it’s a larger run off, but that’s -- it may account for some of it. We haven't analyzed it that carefully, but we do know that when we do renew the mortgage we're making sure that the documentation is 100%.

Dylan Stewart

I think just -- sorry go ahead.

Martin Reid

Hi Dylan, it's Martin, just on the commercial, we don’t disclose that, but it will be well below the 70% mark.

Gerald Soloway

I wouldn’t -- it will be in the 65% range, but we don’t disclose it, but based on how we land and what we do we make sure there is plenty of equity.

Dylan Stewart

One final question just on the preferred share exposure, not unique that you've taken big realized loss give the state of the markets, but just wondering what the nature of your exposure is in that preferred share and what would it take for -- to realize an impairment in the income.

Martin Reid

Yes, its Martin here, for an impairment it would need a credit event to trigger that and we analyze that portfolio on a regular basis. Each of the names that's in that portfolio and it’s a variety of names and a variety of sectors. And we don’t see anything at this stage of the game that would trigger a credit event.

Dylan Stewart

Okay. That’s perfect. Thank guys.

Gerald Soloway

Thanks Dylan.

Operator

Your next question comes from the line of Jordan Hymowitz from Philadelphia Financial. Your line is now open.

Jordan Hymowitz

Hey, thanks guys, Gerald you can comment on it but is a tender in the range of possibilities in other words, just be a buyback or might a possibility be a dodge tender above market.

Gerald Soloway

Go ahead.

Martin Reid

It is a Dutch tender.

Jordan Hymowitz

Oh, it is a Dutch tender. Okay. I am sorry.

Gerald Soloway

Let me just clarify it. It's highly likely that that's the approach that we take.

Jordan Hymowitz

Okay. And my second question is you mentioned your efficiency ratio was going to stay at this level for the least the next six months, but if we were looking for year or year and half, what do you think is quote a normalize efficiency ratio once the acquisition gets integrated.

Robert Morton

So we don’t give that guidance anymore, but we will say 28% to 32% and I would think we get back into the range.

Jordan Hymowitz

Okay. Thank you very much.

Gerald Soloway

Okay, thanks Jordan.

Operator

Your next question comes from the line of Graham Ryding from TD Securities. Your line is now open.

Gerald Soloway

Good morning, Graham.

Graham Ryding

Good morning. How are you? Just with the substantial issuer bit, I appreciate the color that you did give, did you need off the approval on that or do you still require risk free approval for something like that.

Gerald Soloway

Again don’t put me in trouble please. It’s one of those things, as much as I would like to talk about it, there are certain things I can’t say and I can’t talk about that and speak -- you're at TDs, speak to your own compliance people and they’ll give you the answer.

Martin Reid

Graham. We have what approval we need to move forward with it, let's put it that way.

Graham Ryding

Okay.

Gerald Soloway

We wouldn't have announced it unless we felt we had all the ducks in line.

Graham Ryding

Okay. That helps. Not sure if you can speak to this or you want to speak to this, but there was some speculation in media just around some succession planning within your firm. Can you care to comment on any developments or non developments in that area?

Martin Reid

No, I've been always very open and the fact that everyone knows how old I’m, I’m 77, I’m in good health, but I think it's something that’s a matter that the Board has talked about and they're thinking about it and they're not ready to make any announcement at this time, but sometime in the future, couple of periods where there will be some announcement forthcoming from the Board, but there is nothing really at this point.

There were some nasty emails that went around, commenting that I was in nail health and I don’t know, I think the short got a very active. Fortunately I’m in good health, just had a checkup not long ago by the doctor and other than he wants me to lose a few more pounds and other than that I think, I’m in pretty good shape and I come to work every day and drive everybody crazy and everything going fine but we’ll have some more to say about it in due course, but I can’t really comment now.

Graham Ryding

Okay. Great. Glad to hear you're in good health.

Gerald Soloway

Thank you.

Graham Ryding

Maybe rather more I can just sneak one in on the net interest margin, there was some expansion there on the non-securitized portfolio, is that around your deposit side and is it a reflection of more deposits on demand as a percentage of your total deposit base?

Martin Reid

Yeah, it’s a little bit of both on the liability side as well as the asset side. So there is some of that happening. I wouldn’t expect that trend to continue though as far as further widening from where that came in.

Graham Ryding

So you gave some guidance that you expect net interest margin in 2016, but roughly in line with your new loans in Q4 of '15. Can you give us an indication of what the net interest margin was on new loans in Q4 '15?

Gerald Soloway

I don’t know if we have that at our finger tips now, but we think the net interest margin should be fairly sustainable at its present levels. We don’t see any deviation upward or downward.

We also see that there has been a constant improvement in the cost of funds with the efficiencies we've been getting and with the various sources and diversification and that’s a slow progress, but we’re very -- we’re quite comfortable saying we see that margin staying pretty constant through the year.

Robert Morton

Yes and some of that widening is the shift in [ISA] rates as well as the change in mix on the balance sheet.

Graham Ryding

Okay. Great. Thank you.

Operator

And I’m showing there are no further questions at this time.

Gerald Soloway

Okay. Well thank you everybody. Thanks for everything. We look forward to -- I’m sorry there was something -- someone else had a question. Steve, are you there?

Operator

Yes a few questions came in just as I made that statement, Stephen Boland from GMP Securities. Your line is open.

Stephen Boland

Good morning, everyone.

Gerald Soloway

Good morning, Steve. How are you today?

Stephen Boland

Sorry I was jumping around a little bit. So I’m not sure if this has been answered. Obviously some conversation with the SIB, you do have some debt maturing as well coming in May.

So ambitious balance sheet plans I think over the next several months, is there any concern about getting that or what are you doing with the debt? Is it going to be refinanced or repaid?

Gerald Soloway

I’m very, very happy to report that the money has been set aside. It's $150 million that we're paying 5.2% that will be paid in full out of resources that are already in the company at this point. They're earning like next to no interest than on an annualized basis about $7.8 million pretax that we won’t have as an expense in the future and that is -- and we're not planning to re-borrow it.

The rules as you're well aware of debt being able to be put into a regulated company have changed fairly dramatically over the five years and you'll notice that when the chartered banks went together there was get back kind of debt, there is a whole bunch of conversion rules.

We don’t need the money. We would look at it if at some point we needed to bolster capital. At this point fortunately we don’t need to. We'll just take the money and we will pay off the debt and hopefully reduce expenses.

Stephen Boland

Can you -- when you pay out this cash as well as the SIB, Martin I am not sure if you -- like what is your Tier 1 go to or your return of capital go themes kind of model that out.

Martin Reid

Yes our CET 1 drops. It's not a dramatic drop.

Stephen Boland

Roughly 1%.

Gerald Soloway

We had to model all that out and it's all been reviewed by the Board.

Robert Morton

This is Rob. We would be -- the way we model it. So we've got a capital plan as you can imagine and tied in a liquidity plan and we look at these things and it takes us the CET 1 still around 17%.

Gerald Soloway

But still very strong.

Stephen Boland

Okay. And just on -- I know you answered to answered to a question on the press, obviously all the financials are getting hurt with prep portfolios. Is there any -- are they mostly financial services preferred or is there any energy preferred in there?

Gerald Soloway

There was nothing in the portfolio that's been shaky or we've looked at the model. They're all investment grade.

Robert Morton

So we've got a mix of cost, but we haven't disclosed exactly what they are, but we have a strong process to review the credit worthiness of it and so we're comfortable where we stand right now, but as you can imagine we're keeping a close eye on this.

Stephen Boland

Okay. That's great. Thanks.

Gerald Soloway

Thanks Steve.

Operator

And we've a follow-up from Graham Ryding with TD Securities. Your line is open.

Gerald Soloway

Hello Graham. Good morning.

Graham Ryding

I am good. Thank you.

Gerald Soloway

Go ahead. Oh, nothing.

Operator

And I am showing there are no further questions.

Gerald Soloway

Well, thank you very much, everyone. Thanks for the call and thanks for your questions and we look forward to reporting to you again in three months and looking forward to all of us having a good year in 2016. Thank you. Good bye.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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