Home Capital's (HMCBF) CEO Martin Reid on Q2 2016 Results - Earnings Call Transcript

| About: Home Capital (HMCBF)

Home Capital Group Inc. (OTC:HMCBF) Q2 2016 Earnings Conference Call July 28, 2016 10:30 AM ET

Executives

Laura Lepore - AVP, IR

Martin Reid - President & CEO

Steve Jenkins - VP, Finance, Capital, and Strategy

Yan Xu - SVP, Finance and CAO

Pino Decina - EVP, Residential Mortgage

Chris White - COO

Analysts

Dylan Stewart - Industrial Alliance Securities

Graham Ryding - TD Securities

Jaeme Gloyn - National Bank Financial

Geoff Kwan - RBC Capital Markets

Stephen Boland - GMP Securities

Operator

Good morning, my name is Jesse and I will be your conference operator today. At this time I would like to welcome everyone to the Home Capital Group Second Quarter Results Conference Call. All lines are on mute to prevent any background noise. After the speakers’ remarks there will be question-and-answer session. [Operator Instructions] Thank you. Ms. Laura Lepore, you may begin your conference.

Laura Lepore

Thank you, operator and good morning everyone. Thank you for joining us to hear about our second quarter financial results. I am Laura Lepore, Home Capital's new head of Investor Relations. I am excited to work with you all and Morton and the team to ensure we continue to communicate transparently with our investors as I did in my previous roles at TD Bank, CFI and New Market Gold. I look forward to meeting as many of you as possible in the coming weeks.

I will also mention that Robert Morton will not be on the call with us today due to a prior commitment. Before we begin, I would like to caution listeners that this presentation provides management with the opportunity to discuss the financial performance and condition of Home Capital Group and as such may contain forward-looking information about strategies and expected financial results. Various factors many difficult to project and control could cause actual results to differ materially from results projected in forward-looking statements. Accordingly, the audience is cautioned against undue reliance on these remarks.

With that I will now turn the call over to Martin Reid, President and CEO of Home Capital.

A - Martin Reid

Thank you very much Laura and good morning everyone and welcome to the Home Capital 2016 second quarter conference call. With me in the room today I have got Steve Jenkins and Yan Xu from our Finance Department. Pino Decina, our Executive Vice President Residential Mortgage and Chris White our Chief Operating Officer.

As Home approaches its 30 anniversary in 2017, I would like to take this opportunity to thank Gerry Soloway for 30 very successful years leading a true Canadian success story, Home Capital. I would also like to thank Gerry for the mentorship he has provided me and many others at Home and I look forward to his continued involvement on the Board.

The Charles Dickens novel, A Tale of Two Cities appropriately describes the state of the housing market in Canada with Toronto and Vancouver leading the way while the rest of the country sees much more moderate activity. The opening line in the Dickens’ novel is it was the best of times, it was the worst of times, with the age of wisdom it was the age of foolishness. This speaks to the concerns that many of us have in the housing market today.

Given what Home has gone through this last year and a half, I can confidently say that the worst of times for Home Capital are behind us and that the best of times are in front of us. I would also say that regulators Home and others in the mortgage industry are using wisdom in order to address much of the foolishness that maybe happening in some of the more profit markets in Canada but more on this later.

As you know, I took over as CEO in May after nine years with the company. Over the last few months I have taken time to review our company and our potential for future growth. I would like to spend a few minutes on some themes from the quarter and address what is important to us moving forward. I will then go through the financial results in more detail and finish with some high level thoughts.

In terms of Home, I will start by saying that our strategy broadly will stay the same. We will ensure we remain Canada's leading alternative lender serving an undeserved market niche. We are better at this than any one and we are going to stick with what has made us successful. In our 30 year of history, this strategy has enabled Home Capital become one of Canada's largest invest mortgage lenders and we have created significant shareholder value during that time.

As the organization has evolved we’ve revisited the way we do business. In addition, the landscape of our industry has evolved over the last few years with increased regulation and governance requirements. In response we have been strengthening Home Capital's structure with the right people and processes to manage a larger business efficiently and support the long term growth of the company with a stronger risk and control framework. This is all part of the process to position Home Capital to take full advantage of the opportunities in the business in a prudent manner. And we are not done we are honing our strategic plan to further mitigate risk, identify further growth opportunities and create lasting shareholder value. Specifically, we will continue to improve performance by focusing on the following top priorities. Rebuilding our residential mortgage business, operational excellence, risk management and allocation and efficient use of capital. I will touch on each area today.

The first area, rebuilding our residential mortgage business. This has been a real focus for all of us at Home and we are seeing some good momentum. We reported combined traditional and Ace Plus and ensured single family residential mortgage originations of $1.37 billion for the quarter and $2.43 billion for the first six months of 2016. This compares to $1.29 billion and $2.26 billion for the same periods of 2015. Those represent increases of 5.7% and 7.8% respectively.

Accelerator or insured originations increased 66% to $464.8 million for the quarter and 80% to $828.6 million for the first six months of 2016. When you add in the significant originations growth and other lines of business we reported total mortgage advances of $2.47 billion for the quarter and $4.26 billion for the first six months. That's up from $2.02 billion and $3.41 billion in the same period last year. That's 22% increase in Q2, 2016 versus Q2, 2015. As we have been saying our real benchmark and originations for 2014 that was the high water mark and a record year for us that year we reported total second quarter of mortgage advances of $2.33 billion and $4.01 billion for the first half of the year. On a total origination basis, we are ahead of 2014 showing we are on the right track and within our different product lines there is room for improvement and we are working hard towards those improvements particularly as it relates to our traditional mortgage product.

Service levels are not where we think they should be for the mortgage broker with slower turnaround times on commitments and verification of income, however, we are improving the process and momentum is picking up. We believe this is our biggest impairment to greater success on the residential side and a number one priority for management. Our investment and broker portal and digitization of internal process will help to address those issues and we hope to see the positive impact of that in the coming quarters.

I am pleased by the traction of our new uninsured product Ace Plus, this is a product we introduced to serve the class of borrowers who just barely miss out on a prime mortgage. Traditionally, we have not targeted these customers. We move quickly to serve these borrowers by rolling out Ace Plus late last year and we are seeing the positive results. We talk a lot about the Home being nimble and innovative and Ace Plus is real proof of that. We originated $115 million of Ace Plus last quarter significantly higher than we what we did in the first quarter. As this is a new product there is no year earlier comparison. And in addition, we are looking at addressing the lower level of originations in our small commercial group and look forward to improved results in this area.

Now turning to operational excellence. Operational excellence is key to attaining positive operating leverage throughout the company and this means getting even better at what we do. To do so we have added to our bench strength and deepen the organization with new expertise. Chris White our new Chief Operating Officer replacing Brain Mosko, who retired earlier this year, is here with us today. Chris brings significant experience from his time at the DNH Corp where he was most recently a senior vice president leading three business lines and before that from CRBC where he was Vice President, Alternative Channels. Chris will be a big resource for me and brings a tremendous skill set to our management team.

We have launched our new broker portal and loyalty program to improve service and turnaround times in the mortgage origination process. These are investments that will help build our pipeline of mortgage business for the future. We are also significantly investing in technology. We have approximately 20 major IT initiatives across the organization. We are moving from an organization with a lot of paper and manual processes to one with more with digital processes. This is a major effort that will improve how we do business. We will able to process more business, more correctly with more control and a better customer and broker experience. The benefits will really start to flow toward the end of the year and into 2017, but I would like to remind everyone that the investment is happening now.

As we mentioned last quarter, we are investing in added resources in our customer retention group. We want to address early discharges as well as renewals and do more to keep those customers that we already have. We have also reduced some fees to be more in step with the industry. We expect lower fees will support our retention initiative and enable us to be more competitive on new originations. We believe these efforts should drive positive operating leverage and bring help portfolio growth more in-line with loan origination growth in future quarters while managing the growth and expenses.

Now turning to risk management, we have supported our deposit diversification efforts with the acquisition of CFF Bank, which is going to be renamed Home Bank later in August. The development of the oaken brand and the creation of the Home Trust high interest savings account, a more diverse base of funding makes our growth more sustainable as we look into the future. We have implemented process changes to enhance safety and soundness of the portfolio and respond to increased broad risks in the environment. As recently highlighted by our own experience and new guidance by [ASFI] [ph]. On the recent ASFI commentary I will say that Home Capital is supportive of all prudent efforts to protect the sustainability and safety of the housing market and the financial systems. And I believe that the steps that we have taken over the last 18 months to strengthen our business have put us on the right track. Now these things do require investment and I want to assure you that we are focused on expenses and we will do everything we can to offset necessary spending with cost savings. These investments are necessary to ensure that Home is ready for the future with the right risk and controlled framework in place for sustainable efficient business model. The biggest part of the increase spending is behind us, but the growth and the cost saving benefits from these investments are in front of us.

Looking at our allocation and efficient use of capital over the last 12 months you have already seen us being more active on the capital allocation side than the years passed. That includes buying back shares through our significant issuer bid or SIB, increased activity on our normal course issuer bid, retiring debt, as well as raising our dividend. In fact in the first half of 2016 we bought back and canceled roughly 282,000 shares under our NCIB program as well as almost 4 million shares under our SIB program. We will continue to use the NCIB more aggressively than we have in the past on an opportunistic basis.

In Q2, our capital levels remained very high with the total capital ratio of 16.82% that's down from the 20% levels where we had been running because of the significant return of capital and debt repayment that took place during the first half of the year. Return on equity is above 16% target at 16.5% and we see this continuing to improve as we build in more positive operating leverage through the end of 2016 and into 2017. As part of our strategic planning process, we are looking at our non-core businesses and asking important strategic questions about the businesses we are in. Our core residential business is our number one priority but for our other businesses we are asking ourselves can we do more. If so how do we get there? Is it organic investment or through M&A or do we look to divest. We are early in this process and I will have more to say about this in the coming quarters but I wanted to give you a sense of how we are looking at the business going forward.

Looking ahead we will continue to focus on all of the areas I discussed as well as where and how we will allocate our capital. Our focus on these areas will help re-position the company for its next phase of growth.

Now turning to our second quarter results and some key highlights. As you saw in the quarter we reported net income of $0.99 per share or $66.3 million versus $1.03 or $72.3 million for Q2, 2015. There are few moving parts that affect to that number. We had approximately $0.01 or 600,000 of impact related to our senior debt in the derivatives associated with them. That debt was retired on May 4, so you won’t see that going forward. Along with this is the coupon on that debt which is at the rate of 5.2% which is close to $8 million on an annual interest expense. We had further $0.02 a share or $1.1 million of drag from CFF. This will diminish overtime as it becomes more integrated in the value of the acquisition as realized. And we had an impact of about $0.02 a share or $1.5 million from a decline in fee income. These fees relate to customers and not to brokers. As we mentioned earlier we adjusted some feed to reflect the marketplace and we will continue to monitor our fees and adjust them where needed to ensure that we are competitive in originating new business as well as retaining our current portfolio.

On the revenue side were some gains related to securitization and as we have mentioned in previous quarters while we often have gains on sales they are unpredictable as it is by nature an opportunistic part of the business. Turing to credit quality we were pleased with how the portfolio is performing. Net non-performing loan as a percentage of gross loans were 33 basis points, there were 34 basis points in the first quarter and 33 basis points for the second quarter of last year. Provisions for credit losses as percentage of gross and ensured loans rose to 8 basis points on an annualized basis from 4 basis points in the first quarter and 7 basis points for the same period in 2015.

On an absolute dollar value basis provisions for credit losses were $2.8 million up from $1.4 million in the first quarter. As we look at what drove that number we are not seeing any particular trends, there is no unusual items in Alberta or any other parts of the country. And as you know given the small size of that number a couple of loans can really push it one way or the other. And while we enjoy having provision for credit losses at the 4 basis points level it was pretty low relative to our historic experience of running in a range of 5 to 15 basis points. We have mentioned in prior quarters that we expected this number to creep higher and this quarter's experiences more in-line with what we have seen historically.

I will also highlight quickly that we are not seeing any unusual credit issues with the mortgages related to the 45 suspended brokers. We are now over 90% through our review of the portfolio originated by these brokers, so we are well on our way to finishing that up before the yearend as we have previously stated. And that portfolio continues to run off and now stands at 1.3 billion and continues to perform in-line with the rest of the portfolio. Finally, I would like to give you a little more color to help with how to think about expenses looking ahead. With all the investments we are making to strengthen the company. We expect expenses to remain elevated as we enter the second half of the year into 2017 at approximately current levels. Longer term, we see growing into these expenses as the company continues to build positive operating leverage.

I will conclude with some brief thoughts on Home Capital's view of the housing market which of course is a key driver of our business. In terms of house prices I think the best of times are probably behind us. Demand is good with limited supply in Toronto and Vancouver and we would characterize the recent frothiness of these markets as being unsustainable and these markets outliers to the rest of the country. But that doesn't mean that the worst of times are before us. We see a much more moderate market ahead of us rather than the double digit price increases that have characterized Toronto and Vancouver recently with the better balance between supply and demand. We don't see any significant move lower in prices.

Conversely, it would appear that the worst of times might be behind the residential market in Alberta as the decline in their residential market show signs of moderating particularly in detached homes in the Calgary market. The balance of the country demonstrates the much more moderate housing market with balanced supply and demand. Now we can't control the housing market but what we can control is our strategy and our execution and our business model is designed to address these changes in the housing market throughout the entire business cycle. And I will reiterate what I said in my opening remarks I believe that the worst of times are behind Home Capital and that the best of times are in front of us. The mortgage business has undergone a lot of change in the last few years and Home is well prepared to move forward driving solid service to our broker partners and customers and delivering exceptional value to our shareholders.

Before I open it up to questions, should you have any inquires offline you can contact our new head of Investor Relations Laura Lepore, who just recently joined us. And with that I will pass it over to Jesse, the operator and open up the lines to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Dylan Stewart of Industrial Alliance Securities. Your line is open.

Dylan Stewart

Good morning. Just a quick question on traditional mortgage balances there, I appreciate the color you gave on the call but just wondering do you feel that it's getting a little bit, the market is going a little bit flat, but it's been a while we have seen growth, we have seen originations broke up here, but the runoff seems to be accelerating a little bit?

Martin Reid

Yes, so the runoff is, so I would say some of the changes we have gone through in the last year and half we were probably under-resourced in addressing some of that runoff. So we’ve addressed that. We added resources and we talked about little bit about this last quarter and we continue to add resources to address it. There are -- brokers like to sort of turn over their clients and they are very quick to try and sort of move clients from one institution to another and what we will do there is look for the early warning signs and then address it and try and keep that customer. So we have addressed that. We think we are going to get little bit better traction, so I am not sure I would look at that runoff in the last couple of quarters as being indicative of future quarters.

Dylan Stewart

Okay, great. And just a quick questions on ASFI, the headlines that we just stress test that they are trying to run in November. Just wondering how what they have disclosed with 40% price declines in Toronto, 50% Vancouver. How that compares with your own internal stress test?

Martin Reid

Yes, it's not out of line with what we do in turn. We do a variety of stress test. So it's not out of line we have been asked periodically to do pretty severe stress test as it relates to the housing market. I think that's common amongst all financial institutions in Canada. But then, and we also do our own outside of what ASFI request.

Dylan Stewart

Okay perfect I will re-queue. Thanks very much.

Martin Reid

Thanks Dylan.

Operator

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

Graham Ryding

Good morning.

Martin Reid

Morning.

Graham Ryding

On the expense side, the efficiency ratio, so these investments you are making this year technology and your broker focused offerings, risk management etcetera. What are the expectation around these initiatives for 2017 like some of these expenses more project related and expect to drop off or should we more just be thinking about the growth in the expense base slows down in 2017?

Martin Reid

Yes, so the growth in the expense base will definitely slowdown. So as it relates to project. So some of that is capitalized but there are - there has been a number of increased expenses as we have gone through this transition in the business. So that will sort of level off and what we will look to see is improved efficiencies. So as the business grows, the growth and expenses won't need to grow with it. So again, as mentioned in my commentary sort of returning to a much more positive operating leverage.

Graham Ryding

So would you, do you have a target for the efficiency ratio or range that you see the business moving to in 2017?

Martin Reid

We don't, but we would like to see it getting down into the low 30s from where we are today.

Graham Ryding

Okay. And then your EPS growth it's obviously running year-to-date well below your immediate term target of 8% to 13%, so given this higher expense base, is it fair to say that this year you are likely going to come below that target but you are looking at 2017-2018 to get back towards those levels?

Martin Reid

Yes, so those are midterm targets. So they are still valid and we will revisit them at the end of the year, but we do see the opportunities where we get back to those levels but I would say it's fair to say for this year we are not going to make that.

Graham Ryding

Okay and then the CFF Bank, where you are at in terms of integrating that platform and what is the timeline around getting those assets basically to be running on your platform in a profitable level?

Martin Reid

Yes, so there are two components to that. One is on the deposit side and one of them is on the mortgage side. The deposit side will migrate later this summer and then on the mortgage side plans are still being worked on that in terms of the timing of that but that -- so that expense will continue to sort of diminish toward the end of the year and then by the end of the year we will really be able to sort of leverage that business. The whole purpose of buying that bank was on the deposit side and that's really what we are hoping to do as we start getting into the fall, really leverage that on the deposit side.

Graham Ryding

Okay. And so, you talked in the call about trying to get your portfolio growth more in-line with your originations so you are sort of I think you did in your traditional booked 7% this quarter and 11% last quarter like is that a reasonable target for growing your non-securitized book?

Martin Reid

Yes, I would say getting up to those levels I mean we are not happy with the lack of growth in that portfolio and as I mentioned in the previous question it was really both sort of the leakage at the back end on renewals and early redemption. So we have been bringing in the business fast enough. It's like trying to fill the back half, we have been filling with water but we don't have the plug in it so we are addressing the back end to reduce the leakage on the back end and then with the originations growth we should start to see that portfolio growing again.

Graham Ryding

Okay.

Martin Reid

In particular as it relates to the traditional mortgage product.

Graham Ryding

Yes, perfect. Thank you.

Martin Reid

Okay. Thanks Graham.

Operator

Your next question comes from the line of Jaeme Gloyn from National Bank Financial. Please go ahead.

Martin Reid

Hi Jaeme.

Jaeme Gloyn

Hi. Good morning. First question is on the margins in this quarter. It appears the average cash balances were a little bit higher than normal. Could you give us a breakdown of what was driving lower margins year-over-year versus is it mix or is it average cash. What will be the sort of split?

Martin Reid

It was a little bit of both. I would say the bigger driver would have been yes that's and I am not sure at this point we can really quantify which one is the bigger driver. But it's a bit of both. It is a bit of a mix of the portfolio and that will be a function of as we securitize and take some of that stuff off balance sheet and then getting the growth back on our traditional. I would say longer term if you want to look at that and that's why we try to give a little bit more clarity around the margins on the different product line. As you start to see the growth of our traditional product as well as the Ace Plus product that will be the big driver of margins.

Jaeme Gloyn

Yes, so is it your intention to maintain somewhat cash balances it seem it's been running little higher in 2016 versus 2015 or do you expect those to sort of run down to more normal levels?

Martin Reid

Yes, the cash balances are things that happen for example in Q1 we had, at the end of Q1 you’re maintain higher cash balances for coming into our SIB or debt repayment things like that. So there is some volatility in that cash balance number. So that I don't think is going to be the biggest drivers and I think what’s going to really drive is going to be the mortgage originations and the mix of that.

Jaeme Gloyn

Okay. Next question is really to non-interest income and specifically the gains on sales of NHA MBS securitizations. It's running a little bit higher in this quarter versus previous quarters at least the Q1. What’s your strategy with respect to realizing gains on the sales of those products and specifically the single family?

Martin Reid

Yes, so lot of that is driven off the originations of the single family. So, as that improves in pieces we will see that continuing, the margins on that are relatively low, they are lower on the multi-res than they are in the single-family part of that business. But I would say longer term as there are capacity constraints and securitizing insured mortgages, we are not up to those and don't see hitting that ceiling for a while but as we do continue to grow the residential and shared business it will start to squeeze out the multi-res insured business that get securitized which is at a much lower margin than the residential. So on a longer term I see that happening over a period of time.

We look opportunistically in terms of the securitization and sometimes there are shorter pools or odd date pools of four year or two year whatever that maybe where the margins are little bit healthier that may impact a particular quarter, but it's -- we have no real control over these spreads on that business it's really is driven by, we’re a price taker on that type of business.

Jaeme Gloyn

Right. So I guess maybe to ask the question differently is the intention to continue to solve the same level of securitizing all family residential mortgages?

Martin Reid

It will probably grow a little bit with the growth of our insured residential mortgages.

Jaeme Gloyn

Okay. So we should expect -

Martin Reid

That's real driver.

Jaeme Gloyn

Tick up a little bit.

Martin Reid

Yes.

Jaeme Gloyn

Okay. And then just one around the strategic planning process. In terms of like it's the last bullet on the slide four reviewing non-core business lines can you just elaborate a little bit on what you see in the non-core business lines right now, where can things be improved, is there opportunities to divest certain businesses, what is your thought process on that?

Martin Reid

So, we are very early in the process but we are reviewing that in terms of capital expenditure so are there opportunities from an M&A perspective and some of the business lines that we are in. Are there opportunities to invest organically whether be in technology or otherwise and as you are going through any capital process you are also going to have it doesn't make sense to have that business line. So we are very early in that process. I just want to sort of just highlight that we are revisiting that. As we talked about in Q1 our intent is to be much more effective in terms of the management of capital both in terms of what we are doing externally whether that's buyback, dividends, M&A opportunities but also internally how we are managing capital. It's one thing to have a lot of capital but in some ways you really want to sort of manage it very carefully as it scares the resource. And so what's where we really want to ask the hard questions about what are we are doing with our capital. Are there opportunities that we are not even looking at today and where we are spending our capital doesn't make sense as there is room for improvement. But it's very early in the process. I mean this is an annual process and it starts around now and culminates towards the end of the year. So as we get into the yearend we will probably have more color on that.

Jaeme Gloyn

Okay. I will leave it to others.

Martin Reid

Okay. Thank you.

Operator

Your next question comes from the line of Geoff Kwan from RBC Capital Markets. Please go ahead.

Martin Reid

Hey Geoff.

Geoff Kwan

Hi, there. I just wanted to get some clarification when you were talking about some of the retention issues, was it just purely, it sounds like it was a staffing issue. Just wanted to get a sense as to, I guess, what you were doing before and then now going forward what might you be doing differently is it just the headcount increase, are there are different things that you are doing to improve the retention of your clients?

Martin Reid

Yes, I would say it's largely a headcount and a focus. So as we have gone through a lot of the transformations we’ve gone through last year and a half that's probably one area where we didn't give it as much focuses as we should have. So as we noticed that we were losing a lot more business than we thought we should be that's where sort of addressing that and we have looked to beep up, so we have added resources and that's the primary response to that is adding resources so there is two parts that one is on the renewal side making sure that we are getting them as they come up for renewal, but there is also early redemption where sometimes you will get a borrower who will call the call center and they will ask for mortgage statement. They have got nine months left or longer they will call for a mortgage statement and no reason why but they will call for mortgage statement and it could be harmless maybe they just need it for financials or their accounts or whatever but often it's an indicator of them shopping the mortgage around or broker trying to sort of move the client to a different lender.

So historically, we had a fair bit of focus on that. Identify when people are requesting an early mortgage statement ahead of maturity and then sort of calling them up finding out why, what do they need it for, if they are shopping around then looking at retaining that customer. So as I say, we in the shuffle and the restructuring of our business we probably not put as a much emphasis on that as we should have. So we have addressed that. We had some headcount in Q1 and we sequentially added more headcount in Q2.

Geoff Kwan

And even if it’s this ballpark and I apologize if I’m misinterpreting it, it sounds like it was more of an issue on the classic side than on the accelerator side. But like on your renewal rates like where they were and what kind of, what was the level that triggered it and ultimately where do you think you can get it going to?

Martin Reid

Yes, it's less on the renewal side. The renewal rates haven't changed that much. It's more on the early redemption and that's where it's less visible so somebody calls in for mortgage statement, the call center sort of takes it and you may not react. The mortgage doesn't mature for nine months, you may not think to react and then all of a sudden, a few months later you get a call that they have already got a deal with somebody else and they are transferring it. And so, getting it before it gets to that point because once it got to that point it's too late. So that's really what the big leakages around.

Geoff Kwan

And what was driving that? Was it just because with a lot of these customers they think that they can get a better - they are proving credit profile and they can get a better rate by refinancing it elsewhere?

Martin Reid

Yes, it's often that either better rates maybe they are looking at refinancing a larger amount, sometimes the mortgage broker initiating it. For us it’s really just identifying that and just identifying it early enough before they’ve committed somewhere else that we have got the opportunity to sort of retain that customer.

Geoff Kwan

Okay. And just the other question I had wit just on the Ace Plus. The way that you described it as targeting, I think you were saying those that didn't quite get the prime mortgage loan and you guys hadn't target than before and just can you refresh my memory because my impression always was, with Home was you guys were looking at least in the original days was getting the types of borrowers that the banks were turning down. So kind of wanted to understand with the classic business where you kind of drive the line of where you say banks, we don't do it but where you guys were then deciding again where you would pick up some of those borrowers but it sound like you were picking up all of them?

Martin Reid

Yes so this would be, so in our traditional product roughly 275 to 325 basis point margin client and they won’t qualify at the bank today and they are not going to qualify six months from now or probably a year from now. Some of them maybe a couple of years down the road, the Ace Plus customers somebody who often has verifiable income but just misses maybe on the credit score. So if they do everything right. They are going to be able to qualify at the big banks pretty quickly. And I don't know, Pino do you want to add some color?

Pino Decina

Yes, hey Geoff. Really that the Ace Plus evolved because of our continued commitment to that and that customer that misses the bank and really as the rules changed over the past two years and really just brought on new segment for us. So, when we look at the Ace Plus customer Martin's point two years ago they were not our customers, plain and simple. They have now - it's almost a new space that’s been created because of the changes in the marketplace. So, really it's just our commitment to constantly looking at the undeserved and catering our products accordingly and the name itself just really speaks to it. The Ace Plus evolve from what was traditionally our Ace product which service the near miss and as the near miss client change, we tweaked it a bit and we went after that market as well and we will keep doing that.

Martin Reid

Yes and it is a lower margin customer. So that's also part of it in terms of efficiently utilizing the balance sheet. We have got balance sheet capacity, so we can look at that customer little bit easier. It's also that type of product that we have securitized in the last quarter. So that helps to sort of retain as much of the margin as we can on that business.

Geoff Kwan

Okay. Great. Thank you.

Martin Reid

Okay thanks Geoff.

Operator

[Operator Instructions] Your next question comes from the line of [Erin Michael] from National Bank. Please go ahead.

Unidentified Analyst

Hi, I just had a question here regarding your buyback that you did in April at 37.60 per share?

Martin Reid

Yes.

Unidentified Analyst

Do you think that was a good use of capital to buy back $150 million of shares at 37.60 given that the prevailing stock price right now?

Martin Reid

Well, I think we would all love to buy at today's price, but at the time yes we do feel that that was the right move. And when we do as mentioned further with the SIB we are also more active in the NCIB and will continue to be more active in the NCIB to be opportunistic in terms of taking advantage of moves in the market.

Unidentified Analyst

So it's okay to buy back the shares above book value?

Martin Reid

Yes, I would say yes, depending on the alternatives for the use of, better to utilize that capital if we can create shareholder value by doing that then yes.

Unidentified Analyst

Okay. Sort of one final question, what do you see ROE going forward? Do you see it at as before or do you see it continuing its decline?

Martin Reid

We have got a midterm targets about 16% and we do see that continuing.

Unidentified Analyst

Okay. Thank you.

Martin Reid

Okay, thanks Erin.

Operator

Your next question comes from the line of Stephen Boland from GMP Securities. Please go ahead.

Stephen Boland

Hey Martin how are you.

Martin Reid

Good.

Stephen Boland

Can you just explain the comment you made about the lower fee income that it's being, the lower fee to the customer and not the broker, what specifically, what fee is that?

Martin Reid

Yes, so there is a variety of fees that we have as it relates to customer activity, everything from statement fees, early discharge fees, late fees, NSF etcetera, etcetera. So it's related to those fees. I just want to make clear that it wasn't related to fees paid to a broker or anything like that but it was related to customer activity and we review those fees on a regular basis. So I think a couple of years, I think two years ago we had increased some fees and there is a little bit of pickup in fee income as a response to that. So we do review those fees from a competitive standpoint, we will make sure that we are in-line with what’s happening in the marketplace.

Stephen Boland

Okay. What is the biggest, I mean, you mentioned three or four of them, what is the biggest component of that because it is down sequentially couple of million bucks and so was it you shaved every the early discharge, the…

Martin Reid

No the primary area would be in the late fee.

Stephen Boland

Okay and can you just go through I guess, I just want to make sure I am clear on this, the Ace Plus is that securitization, is that the bank sponsored conduit that you are mentioning?

Martin Reid

That's correct, yes.

Stephen Boland

Okay. And what’s the benefit of using that conduit with versus CMHC because I presume in the near prime you were just insured and put it through CMHC, right?

Martin Reid

Yes. So this wouldn't qualify for insurance. So it would just barely mis-qualifying for insurance so it is I mentioned it could be its verifiable income and everything but maybe the credit score is just slightly below the cut off mark. So it wouldn't qualify for insurance so that's why it wouldn't make into the CMHC sponsored programs.

Stephen Boland

Okay. And how, what’s the pricing like in terms of gain, is the pricing that much different is it 1% or 2% maybe it's in the details I apologize if it is?

Martin Reid

Yes. So it doesn't get de-recognition. So it doesn't generate a gain on sale the way CMHC does. So on the CMHC side we only get the gain on sale once we sell the interest only strip and we get the de-recognition. So on this product we can't get the de-recognition, so it will show up in interest income. But what it does do for us is it allows us to get a cheaper source of funding for that product. So if were to fund that product through our deposits, the margin would probably be somewhere I would say 30 to 50 basis points less.

Stephen Boland

Okay.

Martin Reid

So that's the big advantage with the securitization, but it wouldn't fit into the CMHC sponsored programs today because it wouldn't qualify for insurance. But as that customer is very close, it's quite possible that a year down the road they very quickly become a prime customer and then they would migrate to our accelerator insured products, and then we could securitize that through CHMC. But the way it's today they wouldn't fit the insured space.

Stephen Boland

Okay. Just a couple of another quick questions. Just on the cash, I know somebody asked earlier about the cash balance. But your portfolio really, the deposits haven't moved up. The deposits have moved up fairly significant when your portfolio hasn't really changed. So is this an active that you are taking on more deposits for some reason and billing that cash balance for liquidity, for I don't know?

Martin Reid

No, it's more around timing of cash flows so there are variety of events where we built up the cash flow overtime where that cash flow maybe required. So it's more as it relates to that and it's not a structural shift in our liquidity model or how we are approaching liquidity. There is a little bit of increase as it relates to the growth in our high SaaS, so as high SaaS grows you have to allocate more to liquid assets than you would if it was a turn deposit. So that would - there would be a little bit because of that.

Stephen Boland

Okay that makes sense. And just getting back, you answered a lot of questions about growth I mean like you said the worse is behind. Should we start to, you have had two quarters here I would say year-over-year declines in net income on a quarterly basis. I mean, we think you can start getting back to that even though a modest increase of year-over-year income like is that part of your -- the worse is behind exactly showing like Q3 and Q4 that you maybe can start generating over dollar of EPS is that the possibility?

Martin Reid

Yes, so for us it's in a -- we look at it overtime so we had started doing some changes internally as it relates to our residential business and then we had the fraud situation which accelerated a lot of those changes, so we spent a lot of time, lot of money and lot of energy from our employees in terms of implementing those changes. In the process of that I would say the biggest downfall has been our service level to the mortgage broker. So that's really what’s impacted originations the most I think is that service levels of the mortgage broker and these are mortgage brokers that we always dealt with and still deal with today. So for us it's and we continue to invest in technology, redefine process and doing it in a way that we are putting the right risk and control framework in place, but trying to get that customer service to the mortgage broker back to where it needs to be. And that's where we are seeing progress on originations if you look at the residential consecutively we’re up about 25% from Q1 to Q2 and we do see that continuing to improve as we improve our service levels for the mortgage broker. And that really is number one priority for us, is getting that back on track but doing it in a prudent way with all the right controls and risk mitigants in place.

So as we do that and in the expenses that we are incurring to do that are being felt today but as the benefit to that starts to hit and originations continue to grow and the portfolio gets back growing, the revenue side of the equation should start to improve. And I would think longer term you will get more efficiency so there is that little bit of overlap where you are spending that money but you are not necessarily getting the efficiencies, longer terms start to gets those efficiencies from the technology that you are putting in place.

Stephen Boland

Okay. I appreciate that. Thanks Martin.

Martin Reid

Okay. Thank you very much Stephen.

Operator

There are no further questions at this time and I will turn the call back over to Mr. Reid.

Martin Reid

Okay. Thank you everyone for listening and participating in our Q2, 2016 conference call and I look forward to updating you on Q3 results and progress on rebuilding our residential business in November. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

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