(Author's note: Our supporting research in this report includes on the ground insight. Through on the ground field work and our internet sleuthing, we began to suspect ties between Re-Charge and HCG that we were able to prove through our retrieval of public filings. For background, our research involved sending investigators to Canada to dig up public documents that can only be retrieved physically from Canadian government offices. Borrow is tight in this name, but we are writing this note as much for longs in the stock who are drawn to the ROE as we are for potential new short sellers. We have NOT reached out to the company for contact, but if the company does decide to respond to this article we would happy to amend the article to include the company's response)
In today's report, The Friendly Bear goes "global". We recently found out the hard way that making it through a TSA screen as a Bear is quite challenging, but particularly for a Bear that seeks to raise questions about a publicly traded Canadian company. Today's report focuses on Home Capital Group (OTCPK:HMCBF)- a company that has been on the radar of numerous celebrity US short sellers (including Steve Eisman of "Big Short" fame). Some view the company as one of the best ways to play the Canadian 'Housing Bubble'. More recently, we have watched from afar and admired the work and insight that has come out of firms such as PAA Research on the name. Given our experience in forensic due diligence into suspect US financial institutions, we thought we may be able to bring something to the table on the topic of Home Capital Group. The stock fits squarely inside the screens that we look for - commodity financial service products with too good to be true stories and alarmingly low reserves.
It also fits within our absolute favorite bucket of shorts - companies that publicly blame short sellers for their woes.
On a May 5, 2015 earnings call, Gerry Soloway, the Chairman and CEO of Home Capital Group, gave his final parting words to the investment community before riding off into retirement. After founding HCG over 30 years prior, he had grown the company into Canada's largest "alternative lender". He had a lot to be proud of as his accomplishments are undeniable as evidenced by the tremendous shareholder value created under his watch. We can imagine that in such circumstances, it would be hard to find just the right last words to say to stakeholders. One could reasonably expect a heartfelt speech thanking shareholders, colleagues, and family for their support over the years. Instead, Mr. Soloway provided the following quip:
Source: Bloomberg Transcripts
Naturally, we asked ourselves - who are these mysterious "shorts" lurking in the shadows. Surely they must be grotesque creatures, misshaped by nature. Our calls in the market suggested that the central shadowy figure behind the Home Capital Group "shorts" comment may be a curious man with ties to chickens based somewhere in Northern California. Naturally, we began to speculate. Who could this mysterious shadowy Chicken Man be?
Our first guess was this guy:
Source: The Chicken Incident
Even as a 300lb bear, we would be afraid of him…
You can then well imagine our shock when we finally discovered that the actual man causing all of this grief for Home Capital Group is pictured below. He appears to be a Chicken Farmer based out of Northern California. We looked into his background to figure out why in the world he had caused so much angst over at Home Capital Group headquarters. Our hypothesis? Price gouging allegations. News reports suggest that Mr. Cohodes sells his organic eggs for$13/dozen. Perhaps Mr. Cohodes will find himself in similar scrutiny as drug companies such as Concordia for his annual egg price hikes?
Source: NYTimes
We say all of this in jest obviously. We have great respect for Mr. Cohodes as we believe he has paved the path for a new generation of skeptics to speak freely when they see something wrong. And if he is willing to offer us a discount on his eggs, we would greatly appreciate it!
Mr. Cohodes successfully piqued our interest in the topic of the Canadian Housing Bubble. Real estate research firm "Capital Economics" recently stated that "Canada's 'Housing Bubble' is 'going to end in tears'. Zerohedge showed just yesterday that the Vancouver Housing market has begun to implode, with Vancouver average home prices down 20.7% in the last month, and 24.5% over the last three months. Even the Bank of Canada recently said that "steep increases in housing prices in the Vancouver and Toronto area are not sustainable". The Globe and Mail claims that Canadian government authorities are in a bind as it has now become very difficult to fix the problems in the market without causing the entire bubble to collapse. In our view, it goes without saying that there is a huge problem in Canada and at some point it is going to reverse itself. What goes up must come down…
Home Capital Group is an "alternative lender". Let's pause for a second here. In The Friendly Bear's experience, whenever a public company describes itself as an "alternative" lende, you can rest assured it has nothing to do with the CEO's fondness for Burning Man festivals, but rather has everything to do with weak credit standards. Why does this matter? Because numerous authorities have now expressed a clear view that there is a housing bubble in Canada that appears to be unraveling, yet despite this fact pattern, Home Capital Group maintains an astoundingly low reserve for loan losses relative to total loans of only ~20bps.
Does this seem prudent? Here you are, effectively a subprime lender, faced with a reality of a suspected housing bubble that even government authorities are worried is on the brink of collapse - yet you maintain one of the lowest loan loss provisions we have ever seen in any lending business in the world.
But this is all obvious. This is all old information. If this is where the Home Capital Group story stopped, we would be doing readers a disservice. But it does not stop here, and what we have uncovered in this report is arguably the single most important data point that has emerged on HCG CN to date, as it would naturally cause any reasonable reader to question the legitimacy of both: a) public statements made by Home Capital Group management, and b) Home Capital Group's financial statements.
So now without further ado…
Please Meet Re-Charge Corporation:
Whenever a public company CEO attacks shorts, we naturally ask ourselves - what are these guys hiding? So as usual, we began to dig. And dig. And dig. We wondered - why would someone retiring from a company still be worried about the short interest in his stock? Perhaps there was a bigger secret that the world had missed. And as we have learned from our research into other suspect financial institutions, perhaps the underlying skeletons in the closet relate to undisclosed related party issues...
So what is Re-Charge Corporation and what is its relationship to Home Capital Group?
A simple Google search of "recharge mortgage Canada" led us to a startling revelation. Despite never being mentioned in Home Capital Group filings, the genius algorithm at Google appears to have connected the dots between the search phrase "Recharge Mortgage Canada" and "Home Trust" - the operating subsidiary for Home Capital Group.
Source: Google, retrieved 8/22/16
While this is obviously only anecdotal in nature, we have often found that Google is able to "connect the dots" much faster than the human mind.
So first, a little background on the Re-charge Corporation.
Despite being currently registered in the province of Ontario as a "Mortgage Broker", Re-Charge has no website and no signage on their office (see Photo A below). At least one employee of Re-Charge has an @gmail.com address listed on his business card (see Photo B below).
Photo A
Source: Photos from our visit to Re-charge's "office"
Photo B
Source: Our researchers got their hands on a Re-Charge business card
In The Friendly Bear's view, it certainly appears as if Re-Charge and its Principals are not seeking out publicity for their mortgage operation.
So naturally, we ask. Why would a mortgage company go out of its way to avoid the spotlight? Mortgage companies by definition have to advertise as aggressively as possible given the competitive nature of the mortgage brokering industry, particularly in the hot Canadian housing market.
So we looked into the Principals behind the Re-Charge Corporation. As you can see below in the most recent regulatory filing available, Re-Charge is owned and managed by three individuals: Robert J. Wilkins, Mark D. Tamminga, and William J. Walker.
We did a quick mortgage agent broker check and found Mr. Wilkins listed as the Principal Broker on the Re-Charge account:
Source: Financial Services Commission of Ontario
We also had a Corporation Profile Report pulled on Re-Charge Corporation as can be seen below.
Source: Corporation Profile Reports from Ontario Government
What do these three men have in common? All three either were or are partners in the Ontario offices of Gowling WLG, a large Canadian based law firm. You can access their profiles on your own through the Gowling WLG website or just Google to confirm these data points. All three also do or did specialize in the real-estate and mortgage industries.
One of these men also happens to currently sit on the Home Capital Group Board of Directors as an 'independent' director.
Please meet a Mr. William J. Walker:
Source: HCG Website / Morningstar
So now let's turn our attention to Mr. Walker.
As folks who follow Home Capital Group will probably recall, we were first introduced to Home Capital Group's most recent board addition in a somewhat unorthodox fashion. During the turmoil surrounding the company in the summer of 2015 when the company disclosed their involvement in what would become at least $1.9 billion in fraudulently originated mortgages, two longtime HCG board members resigned. To fill one the vacated seats, the company appointed William J. Walker as an independent director. Oddly though, there was no separate press release or regulatory filing announcement regarding his appointment. Shareholders were made aware of this material event via a very brief mention at the end of the prepared remarks on the Q3 2015 earnings conference call by Mr. Soloway:
Source: Bloomberg Transcripts
But it gets even more odd...
HCG lists its board of directors on two different websites- one for the main operating subsidiary (Home Trust), and one for the publicly traded holding company (Home Capital Group). The first one (Home Trust) does not use hyperlinks, rather it simply lists the director's bio under their respective names. Curiously, for William J. Walker, we only see his name with the page abruptly cut off. On the second version of the bio page on the Home Capital website, if you try to click on the link for William J Walker, nothing happens. Unlike other board members, the bio doesn't appear in newly launched window. ( Author note: this was true as of our final publication on 8/22/16).
Source: http://www.hometrust.ca/officers.aspx
NOTE: We did NOT cut the page off. Walker's bio really is just left empty in the Hometrust.ca page.
Then the holding company version of the bio page:
Source:http://www.homecapital.com/directors_officers.asp
The highlighted link is dead as of this publication.
One could reasonably infer that it appears that HCG doesn't want us to know much about this new board member.
So perhaps these omissions are purely coincidental. Perhaps the owners of Re-Charge are really private people who greatly value anonymity. And perhaps, with all of the fallout at HCG over mortgage fraud, Home Capital Group just forgot to file a separate press release on William J. Walker and then carelessly omitted his bios from both websites.
That is certainly one reasonable theory of what could have happened here.
We propose an alternative reasonable theory below.
We sent our team of researchers to the Canadian Land Registry Office to try to find out more about Re-Charge Mortgage. We wondered - could we find any ties between Re-Charge and Home Capital Group?
And as you can see in the public filings below directly taken from the Canadian Land Registry Office, on at least 14 occasions in the fourth quarter of 2015, Home Capital sold loans to Re-Charge.
Source: We had researchers visit Land Registry Offices in Ontario to get copies of these documents. You can recreate our work by visiting this website and then flying to Canada.
Re-charge has never been mentioned as a related party in HCG filings. Furthermore, given Mr. Walker's apparent ties to Re-Charge as one of its Principal Officers, his "Independent" status is certainly up for debate.
So For the time being, let's ignore that HCG appears to have failed to disclose a material related party relationship in any of their filings. We can get into that later.
Related party or not, why would HCG want to move loans off its books and transfer them to Re-Charge?
First, let's speculate on reasons why HCG would NOT WANT to loans off its book.
Reasons HCG would NOT want to sell mortgage loans:
Reason 1: In the last few years, provisioning for losses has essentially been zero, indicating no credit deterioration whatsoever. Why sell a performing, productive loan in your core business?
Reason 2: Post the disclosure of underwriting fraud, HCG has repeatedly struggled to hit origination targets in their core residential mortgage business. Why make the hurdles higher by transferring good loans and reducing the balance sheet?
So a lender that is struggling to generate growth that has a performing loan is unlikely to want to move a loan off balance sheet. This is a reasonable inference that any reasonable person could make.
Enter Stephanie Anne Marie Harvey.
Harvey, as you can see below, acted as both the Transferor(s) and the Transferee(s) of the loans on behalf of GLH Limited Partnership (GLH..i.e. Gowling Lafleur Henderson). Harvey is currently an associate at Mr. Walker's law firm, Gowling and currently "practices in the area of banking and insolvency law, with a particular emphasis on the rights and remedies of mortgage lenders." Furthermore, she is a member of the "Recovery Services Group" which among other things, " helps clients ensure a speedy and effective resolution of their defaulting mortgages."
We suggest you visit these two links to familiarize yourself with Recovery Services Group and Harvey:
Link 1: https://gowlingwlg.com/en/canada/sectors-services/services/banking-finance/recovery-services
The Transfer Document References Harvey Below
Source: We had researchers visit Land Registry Offices in Ontario to get copies of these documents. You can recreate our work by visiting this website and then flying to Canada.
Harvey Biography
Source: Gowling WLG
On the second document, you can see that William Walker HIMSELF signed off on thetransfer of the loans. Walker is also a member of the aforementioned Recovery Services Group.
Source: We had researchers visit the Land Registry Office in Ontario to get copies of these documents. You can recreate our work by visiting this website and then flying to Canada.
Given the description of the Recovery Services Group, it seems more than reasonable to assume that these loans were sold because they were in some form of DEFAULT. So now we propose an alternative theory to explain these strange balance sheet maneuvers…
Our hypothesis: Home Capital Group does not want anyone to know that a company owned by one its purportedly independent board members is taking defaulted loans off their books.
Now before you say "Okay, fine, this might smell bad but it's just fourteen loans Friendly Bear, so who cares?"
Two rebuttals:
Rebuttal 1: We were only able to gather evidence of fourteen loans that were sold from HCG to Re-Charge because those are the ONLY two days we could query the Land Registry Office. The Land Registry Offices imposes structural limitations on the ability of members of the public to query the database. If we were able to query the database by Transferor or Transferee, we believe that many more loans would surface. It would simply be too large of a coincidence to discover that the only loans sold to Re-Charge occurred on the EXACT same dates that we had access to the database.
Rebuttal 2: Even if you take the extraordinarily conservative view that these are the only loans that were sold to Re-Charge, the total amount of the principal involved is about HALF the total amount HCG provisioned in the quarter- just on those loans ALONE!
Source: HCG Filings. Also note: our math above assumes approximate Average Loan Balance = $300,000 * 14 = C$ 4,200,000
The transfer fact pattern we have identified above certainly appears to show that one could reasonably infer that Home Capital Group did in fact experience defaults. Shocking!
Friendly Bear, are you telling me that a subprime lender may actually face defaults?
It might also be useful at this point to go back and look at what HCG management has repeatedly said about the performance of the nearly $2bn in fraudulently originated loans that were identified last year.
As you can see below, HCG has repeatedly kept to the party line that all those loans were performing BETTER than the company average (how the company defines "better" than its supposedly near-perfect default experience is a topic for another day). When asked why they didn't need to take provisions higher in the wake of the fraud disclosure, management has repeatedly made comments like the one below:
Gerry Soloway, HCG Earnings Call, November 5, 2015
Source: Bloomberg Transcripts
Our report now raises the question of whether the only reason HCG CN was able to make these previous claims is because it was offloading loans to Re-Charge before they had to report delinquencies...
And one other point about the loans that we found…Notice that 12 of 14 loans in the above documents were based in the town of Brampton. Brampton, while likely a very nice place, also happens to be widely known in the mortgage circles of Ontario as ground zero for mortgage fraud. In fact, we have spoken to many mortgage brokers who refer to the practice of falsifying income or employment on a mortgage application as doing it "The Brampton Way". Needless to say, it didn't surprise us that a majority of the tiny sample we were able to uncover had originated in Brampton.
So what is The Friendly Bear's summary view on all of this information?
- We believe that given William J. Walker's ties to Re-Charge, he does not meet the definition of an "independent" board membe
- Home Capital transferred mortgage loans to an undisclosed related party
- The transfer agent for those loan sales are member of Gowling's Recovery Services Group
- A critical function of the Recovery Services Group is to help clients remedy defaulting mortgages
- Home Capital has repeatedly stated that the fraudulently underwritten loans on their balance sheet are performing
- Home Capital has never disclosed their relationship with Re-Charge Corporation
- In the last 8 quarters, Home Capital's average provision for loan losses is 5 basis points. In other words, if their financial statements are in fact accurate, the company is essentially asserting that it has essentially NO problem loans
- Home Capital is largely dependent on brokered deposits as their primary funding source- putting them at significant risk should confidence decline as wholesale deposit flight could ensue
- Broker GICs (Guaranteed Investment Certificate) are over 80% of the deposit mix as of the June quarter.
Perhaps there is a simple explanation for all of the above and our inferences to the facts are incorrect.
We therefore challenge Martin Reid and management to address the following questions:
- Of all the potential available candidates, why appoint William J Walker to the board given his apparent conflict of interests
- Would nobody else entertain joining the board given the extenuating circumstances, i.e. disclosure of mortgage fraud, at the time?
- Why were HCG loans being transferred to Re-Charge? Are they in fact in arrears at the time of the disposition?
- Were the loans sold to Re-Charge tied to any of the mortgage brokers that HCG terminated due to mortgage fraud?
- We only found fourteen loans but there are likely significantly more. Are there more of these Re-Charge disposals?
- What impact would keeping these balance sheets have on your provisioning? (hint, our suspicion is that it would go up… by a lot)
- How have you failed to disclose this relationship without violating Canadian securities laws?
In an interview on BNN with Paul Bagnell, shortly before their Q216 earnings call on July 28, 2016, current CEO Martin Reid made an interesting statement:
Source: Twitter
Author's post-publication note: Amber Kanwar merely tweeted the comment above. The quote comes from an interview on BNN with Paul Bagnell. Ms. Kanwar did NOT endorse the statement above. However, you can find the statement yourself by searching for Mr. Bagnell's interview.
We wholeheartedly agree Mr. Reid…fraud is certainly "part" of the business.
Disclosure: I am/we are short HMCBF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am/we are short Home Capital Group. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
